J Fleet Oil & Gas Production Co L L C v. Chesapeake Louisiana L P et al
Filing
46
MEMORANDUM RULING re 34 MOTION for Partial Summary Judgment filed by Chesapeake Energy Marketing Inc, Chesapeake Energy Marketing L L C, Chesapeake Louisiana L P, Chesapeake Energy Corp. Signed by Chief Judge S Maurice Hicks, Jr on 3/22/2018. (crt,McDonnell, D)
UNTIED STATES DISTRICT COURT
WESTERN DISTRICT OF LOUISIANA
SHREVEPORT DIVISION
J. FLEET OIL & GAS
CORPORATION, L.L.C., ET AL.
CIVIL ACTION NO. 15-2461
VERSUS
JUDGE S. MAURICE HICKS, JR.
CHESAPEAKE LOUISIANA, L.P.,
ET AL.
MAGISTRATE JUDGE HORNSBY
MEMORANDUM RULING
Before the Court is Defendants Chesapeake Louisiana, L.P.; Chesapeake
Operating, L.L.C.; Chesapeake Energy Corporation; and Chesapeake Energy Marketing,
L.L.C.’s (collectively, “Chesapeake”) “Motion for Partial Summary Judgment” (Record
Document 34). Chesapeake seeks to dismiss certain claims asserted by J. Fleet Oil and
Gas Production Company, L.L.C (“J. Fleet”) and Martin Producing, L.L.C. (“Martin”)
(collectively “Plaintiffs”). For the reasons which follow, Chesapeake’s “Motion for Partial
Summary Judgment” is hereby GRANTED.
FACTUAL AND PROCEDURAL BACKGROUND
In or around the summer of 2004, J. Fleet and Martin marketed the Martin/J. Fleet
Prospect to a number of oil and gas companies as an opportunity to acquire a large
contiguous block of leased acreage in which the oil and gas company could acquire a
100% working interest position in the leased acreage and have full operational control of
the exploration and development of the multiple potentially productive zones and
formations within the Martin/J. Fleet Prospect. On August 23, 2004, Chesapeake entered
into a Participation Agreement (the “Agreement”) with Martin. See Record Document 342 at 1. The Agreement established an area of mutual interest (“AMI”) comprised of lands
1
in Caddo Parish, Louisiana. See id. As part of the Agreement, Martin agreed to assign
the oil and gas leases within the AMI to Chesapeake, respectively reserving an overriding
royalty interest 1 (“ORRI”) on each lease assigned in a percentage amount equal to the
difference between the lessor’s royalty and 28%, thus providing Chesapeake with a net
revenue working interest percentage in each lease within the AMI of not less than 72%.
See id. Identified in Exhibit “B” to the Agreement, the assignment reads as follows:
Assignor hereby reserves an overriding royalty interest applicable to each
lease, equal to the difference between the lease royalty and 28% of all oil,
gas and casinghead gas produced, saved and marketed from the lands
covered by said leases. It is the intent that Assignor (Plaintiffs) shall deliver
not less than a 72% net revenue interest to Assignee (Chesapeake) on each
of the leases.
See id. at 10. All parties recognized that Martin would transfer or assign one-half of the
Martin/J. Fleet ORRI to J. Fleet and that Martin was acting for itself and on behalf of J.
Fleet.
The Agreement was first amended on November 17, 2004, to modify and expand
the AMI. See id. at 13. On April 4, 2007, the Agreement was amended a second time to
reduce the amount of ORRIs owned by J. Fleet in the AMI. See id. at 16. Pursuant to the
Agreement, Chesapeake entered into seven contracts of assignment with J. Fleet,
whereby Chesapeake assigned an ORRI in the AMI to J. Fleet. See Record Document
34-3. Each of the seven assignments to J. Fleet contained the following express
provision:
Proceeds of production attributable to the overriding royalty interest
assigned herein shall be due Assignee from date of first production
attributable to the particular lease assigned herein.
1 J. Fleet argues it agreed to sell its prospect for cash and the retention of a cost free net revenue interest
(“NRI”) from the lessee’s working interest. See Record Document 1 at 8. However, the Agreement itself
uses the term “overriding royalty interest” (“ORRI”). See Record Document 34-2 at 1. The Court addresses
this issue in detail later in its analysis.
2
Said overriding royalty interest shall be free of all development, production,
and operating expense of any wells drilled on the subject lands or land
pooled therewith. Said overriding royalty interest shall bear and pay its
portion of gross production taxes, pipeline taxes, and all other taxes
assessed against the gross production subject to said overriding royalty
interest.
See id. Exhibits B-O.
J. Fleet alleges that from the beginning of payment of J. Fleet’s ORRI Chesapeake
was improperly deducting various costs and expenses from J. Fleet’s ORRI in violation
of the specific contractual agreements among the parties. See Record Document 1 at 15.
J. Fleet alleges the improper deductions include costs such as compression costs, fuel
usage and gathering costs as well as other costs or expenses incident to the production
and sale of the oil and gas including, but not limited to, costs and expense of exploration,
drilling, development, operating, marketing and all other costs. See id. Chesapeake
allegedly deducted these costs without always disclosing what deductions were being
made. See id. J. Fleet alleges Chesapeake is in breach of their contractual obligation to
pay J. Fleet its ORRI from Chesapeake’s working interest without any such deductions.
See id. J. Fleet asserts Chesapeake’s violations have resulted in Chesapeake improperly
claiming in excess of $1 million for itself at the expense of and damage to J. Fleet. See
id. at 16.
On or about December 17, 2013, J. Fleet sent a demand letter to Chesapeake
demanding full and proper payment for all ORRI payments due and owing on all wells
and units under the Agreement and the seven contracts of assignment. See Record
Document 1-1 at 104. On February 28, 2014, Chesapeake responded to J. Fleet’s
demand letter admitting it was deducting post-production costs from J. Fleet’s ORRI. See
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id. at 113. Chesapeake refused to cease deducting development, production, and
operating expenses or costs from J. Fleet’s ORRIs, resulting in J. Fleet filing the instant
suit on October 2, 2015. See Record Document 1. J. Fleet seeks: (1) a declaratory
judgment pursuant to 28 U.S.C. § 2201; (2) a judgment of accounting; (3) a prohibitory
injunction; (4) damages for Chesapeake’s intentional, bad-faith breach of contract; and
(5) damages for Chesapeake’s intentional breach of fiduciary duties owed to J. Fleet. See
id. at 17-21. Martin filed a Motion to Intervene on May 2, 2016, and was added to the
lawsuit on May 3, 2016. See Record Document 17. Chesapeake filed a Motion for Partial
Summary Judgment on August 25, 2016, seeking to dismiss Plaintiffs’ claim that
Chesapeake improperly deducted post-production costs. See Record Document 34.
LAW AND ANALYSIS
I.
LEGAL STANDARDS
A. SUMMARY JUDGMENT
Rule 56 of the F.R.C.P. governs summary judgment. This rule provides that the
court “shall grant summary judgment if the movant shows that there is no genuine dispute
as to any material fact and the movant is entitled to judgment as a matter of law.” F.R.C.P.
56(a). Also, “a party asserting that a fact cannot be or is genuinely disputed must support
the motion by citing to particular parts of materials in the record, including ... affidavits ...
or showing that the materials cited do not establish the absence or presence of a genuine
dispute, or that an adverse party cannot produce admissible evidence to support the fact.”
F.R.C.P. 56(c)(1)(A) and (B). “If a party fails to properly support an assertion of fact or
fails to properly address another party’s assertion of fact as required by Rule 56(c), the
court may ... grant summary judgment.” F.R.C.P. 56(e)(3).
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In a summary judgment motion, “a party seeking summary judgment always bears
the initial responsibility of informing the district court of the basis for its motion, and
identifying those portions of the pleadings ... [and] affidavits, if any, which it believes
demonstrate the absence of a genuine issue of material fact.” Celotex Corp. v. Catrett,
477 U.S. 317, 323, 106 S.Ct. 2548, 2553 (1986) (internal quotations and citations
omitted). If the movant meets this initial burden, then the non-movant has the burden of
going beyond the pleadings and designating specific facts that prove that a genuine issue
of material fact exists. See Celotex, 477 U.S. at 325, 106 S.Ct. at 2554; see Little v. Liquid
Air Corp., 37 F.3d 1069, 1075 (5th Cir. 1994). A non-movant, however, cannot meet the
burden of proving that a genuine issue of material fact exists by providing only “some
metaphysical doubt as to the material facts, by conclusory allegations, by unsubstantiated
assertions, or by only a scintilla of evidence.” Little, 37 F.3d at 1075.
Additionally, in deciding a summary judgment motion, courts “resolve factual
controversies in favor of the nonmoving party, but only when there is an actual
controversy, that is when both parties have submitted evidence of contradictory facts.” Id.
Courts “do not, however, in the absence of any proof, assume that the nonmoving party
could or would prove the necessary facts.” Id.
B. CONTRACT INTERPRETATION
“Contracts have the effect of law for the parties” and the “[i]nterpretation of a
contract is the determination of the common intent of the parties.” La. Civ.Code arts.1983
and 2045. “When the words of a contract are clear and explicit and lead to no absurd
consequences, no further interpretation may be made in search of the parties' intent.” La.
Civ. Code art. 2046. “When the language of a contract is clear and unambiguous, it must
5
be interpreted solely by reference to the four corners of that document.” Dickson v.
Sklarco L.L.C., 2013 WL 1828051, at *3 (W.D. La. Apr. 29, 2013), citing Tammariello
Properties, Inc. v. Med. Realty Co., Inc., 549 So.2d 1259, 1263 (La. App. 3 Cir. 1989).
Words of art and technical terms must be given their technical meaning when the
contract involves a technical matter, and words susceptible of different meanings are to
be interpreted as having the meaning that best conforms to the object of the contract. See
La. Civ. Code arts. 2047 and 2048. In Louisiana, “[p]arol or extrinsic evidence is generally
inadmissible to vary the terms of a written contract unless there is ambiguity in the written
expression of the parties’ common intent.” Blanchard v. Pan-OK Prod. Co., Inc., 32,764
(La. App. 2 Cir. 4/5/00), 755 So.2d 376, 381. “A contract is considered ambiguous on the
issue of intent when it lacks a provision bearing on that issue or when the language used
in the contract is uncertain or is fairly susceptible to more than one interpretation.” Id.
When a contract provision relating to mineral rights is ambiguous on a pivotal
issue, the Louisiana Supreme Court and Courts of Appeal have interpreted the provision
as having the meaning that best conforms to the object of the contract in light of the nature
of the contract, equity, and usages, including extrinsic evidence as to custom and
practices in the oil and gas industry. See Musser Davis Land Co. v. Union Pac. Res., 201
F.3d 561, 565-67 (5th Cir. 2000); Henry v. Ballard & Cordell Corp., 418 So.2d 1334, 133940 (La. 1982).
II.
ANALYSIS
A. Plaintiffs Retained an Overriding Royalty Interest
At issue is whether Chesapeake assigned an ORRI or a cost-free net revenue
interest (“NRI”) to Plaintiffs. The difference in characterization is significant. Chesapeake
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asserts the assignments unambiguously provide that Chesapeake assigned “an
overriding royalty interest … payable out of the oil and gas leases.” Record Document 41
at 2. Plaintiffs ask the Court to look beyond the formalities of the transaction and find their
interest was not an ORRI, but rather a cost-free NRI; and that the assignments were
actually subleases. See Record Document 39 at 18. Although Plaintiffs are correct that
the parties entered into subleases rather than assignments, this distinction does not
detract from or affect the fact that Plaintiffs obtained an ORRI, not a cost-free NRI.
Louisiana law requires that courts look beyond the superficial formalities of a
transaction and examine the substance of an agreement to determine the true nature of
the transaction and the rights, duties, and obligations created therein. See Howard
Trucking Co. Inc. v. Stassi, 474 So.2d 955, 960 (La. App. 5th Cir. 1985), aff’d 485 So.2d
915 (La. 1986). The distinction between an assignment and a sublease is that in an
assignment, the lessee transfers all of his rights in a lease, whereas in a sublease, the
lessee retains some control or interest in the lease. See Joslyn Mfg. Co. v. T.L. James &
Co., 836 F.Supp. 1264, 1270 (W.D. La. 1993). The substance of the assignments make
it clear that Plaintiffs retained an interest in the leases – “the assignment shall reserve an
overriding royalty interest to Martin….” Record Document 34-2 at 1. Louisiana courts have
long held that the reservation of an overriding royalty interest is, in and of itself, sufficient
to “stamp the transfer as a sublease.” Bond v. Midstates Oil Corp., 53 So.2d 149, 154
(La. 1951). Therefore, it is clear that the “assignments” between Plaintiffs and
Chesapeake were in fact subleases. However, the main issue is not whether Plaintiffs’
interest was subleased or assigned; but whether Plaintiffs’ retained interest is classified
as an ORRI or a cost-free NRI.
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Plaintiffs argue that only the owner of executive rights over oil and gas can grant
oil and gas leases by which the lessor retains a share of the production free of cost, i.e.,
a royalty. See Record Document 39 at 20. Once the oil and gas lease is granted, the
lessee (Plaintiffs) becomes the owner and holder of all obligations to develop the leased
premises. See La. R.S. § 31:122. Plaintiffs contend that the lessee, known in the oil and
gas industry as the “working interest owner,” can then transfer all or part of his
development rights, duties, and obligations by contract and in doing so may create a
contractual right to share in the proceeds of the sale of production. See Record Document
39 at 20. It is Plaintiffs’ belief that the retention of a right to share in the proceeds of the
production by a working interest owner is a revenue interest, not a royalty. See id.
Plaintiffs assert that such a retained revenue interest is commonly referred to an
“overriding royalty” – even though it is not a royalty as defined by Louisiana law. See id.
Plaintiffs again ask the Court to look beyond the formalities of the Agreement and
examine the substance to determine that Plaintiffs’ interest was a cost-free NRI rather
than an ORRI. However, after doing so, the Court finds Plaintiffs’ interest was indeed an
ORRI. Plaintiffs’ argument is flawed in two ways: (1) Chesapeake never claims Plaintiffs’
interest is a regular royalty, but rather an overriding royalty interest and (2) the term
“overriding royalty interest” is a defined, technical term used throughout the agreements
by sophisticated parties, making the parties’ intent unambiguous.
“‘Overriding royalty’ is a term of art, pregnant with meaning and legal
consequences of which defendants as sophisticated parties surely were aware.” Shell
Offshore, Inc. v. FMP Operating Co., 1988 WL 125455, at *3 (E.D. La. 1988). An
“overriding royalty” is “[a]n interest in oil and gas produced at the surface, free of the
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expense of production, and in addition to the usual landowner’s royalty reserved to the
lessor in an oil and gas lease.” Patrick H. Martin and Bruce D. Kramer, Williams and
Meyers, Oil and Gas Law, § 418.1 (2015). In the parties’ Participation Agreement,
Plaintiffs agreed that:
[Plaintiffs] shall simultaneously assign and deliver to Chesapeake 100%
interest in the Leases. The assignment shall be subject to (i) all the terms
and conditions of each of the Leases and (ii) shall reserve an overriding
royalty interest to [J. Fleet] equal to the difference between the existing
lease royalty and 28%.
Record Document 34-2 at 1. The parties recognized the overriding royalty interest would
be reserved by Plaintiffs in addition to the “existing lease royalty.” See id. The parties’
characterization of the interest fits squarely within the traditional definition of an
“overriding royalty.” The Agreement’s language and the definition of an “overriding
royalty” make it clear that the parties did indeed intend to create an ORRI, rather than a
cost-free NRI.
After examining the substance of the Agreement, the Court believes it is
unambiguous that the parties created an ORRI. In Shell, the Louisiana federal court
rejected a nearly identical attempt to discard the plain language of an overriding royalty
reservation. There, Shell had assigned an oil and gas lease as part of a farmout
agreement, but reserved an interest in the lease, which reservation explicitly
characterized the interest as an “overriding royalty.” See Shell Offshore, Inc., 1988 WL at
*1. Shell later filed suit, arguing that it was being paid as a working interest owner, rather
than an overriding royalty interest owner. See id. at *2. Despite the plain language of the
assignment, the defendants argued that the reservation created something called a
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“hybrid working interest,” and, alternatively, that the language was ambiguous, requiring
the admission of parol evidence. See id.
The court addressed the defendants’ argument (which is identical to Plaintiffs’
argument here) and stated:
Defendants cite Delta Drilling Co. v. Maxwell D. Simmons, et al., 338
S.W.2d 143 (Tex.1960), for the proposition that the label applied to an
interest is not dispositive concerning its true nature and that the court must
make the final determination on that issue. I agree, but in making this final
determination, I can do no more than look to the document creating the
interest so as to understand the interest's characteristics. Naturally, this
investigation must take into account how the interest is designated by the
contracting parties, because that designation says a great deal about the
parties' intention concerning the nature of the interest. More specifically, the
term “overriding royalty” is not merely an empty label. It is a useful
substantive term which parties can employ to signify the existence of
contractual conditions which would otherwise have to be described in
minute detail. Only if other aspects of the agreement are wholly inconsistent
with use of the term would it be proper to recharacterize the interest created.
The court ultimately held that, because the rest of the agreement was not
“wholly inconsistent” with the term, the assignment unambiguously created
an overriding royalty interest, and parol evidence was excluded.
See id. at *3.
Here, even if the parties had not used the term “overriding royalty interest,” which
unambiguously establishes their intent that Plaintiffs were reserving such an interest, the
parties’ broader arrangement is not only “wholly []consistent” with that intent, it clearly
reinforces it. Plaintiffs, in their sur-reply, argue that Chesapeake fails to rely on a single
case that was decided under or cites to Louisiana law. 2 See Record Document 44 at 2.
However, there are Louisiana cases which support Chesapeake’s position.
In Agurs v. Amoco Prod. Co., 465 F.Supp. 154, 157 (W.D. La. 1979), the court,
interpreting Louisiana law, considered a party’s argument that a certain stipulated interest
2
Although Shell was decided by the Eastern District Court of Louisiana, the court applied Texas state law.
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was in the nature of rental, rather than an overriding royalty, despite the plain language
of the relevant agreement. The court rejected the argument, reasoning as follows:
Contrary to defendant’s assertions, and taking the instrument as a whole,
we are convinced that the royalty stipulated is an overriding royalty, not
rental royalty. First, we are persuaded by the use of the term ‘overriding
royalty’ throughout the 1962 agreement. The parties to the agreement are
experienced oil men and must have had knowledge of the denotation and
connotations of the phrase. Had the parties intended that the stipulated
royalty be treated as rental, it would have been easy enough to so provide.
Id. at 158.
Here, as in Agurs, the term “overriding royalty interest” is explicitly and repeatedly
used throughout the parties’ agreements. J. Fleet, Martin, and Chesapeake all have
extensive experience in the oil and gas industry and are presumed to have had knowledge
of the denotation and connotations of the phrase. Additionally, language used throughout
the parties’ agreement makes a clear distinction between an ORRI and a NRI. In each of
the assignments, there are references to a NRI owned by Chesapeake side-by-side with
references to an ORRI retained by Plaintiffs. Had the parties intended that Plaintiffs’
interest be a NRI, it would have been easy enough to so provide. Accordingly, the Court
finds the agreements unambiguously create an ORRI.
B. Chesapeake was Entitled to Deduct Post-Production Costs
In Louisiana, the general rule is that post-production costs are shared pro rata
unless a lease says otherwise. See Magnolia Point Minerals, L.L.C. v. Chesapeake
Louisiana, LP, 2013 WL 3989579, at *4 (W.D. La. 2013); Merrit v. Southwestern Electric
Power Co., 499 So.2d 210 (La. App. 2 Cir. 1986). Louisiana, as well as the oil and gas
industry in general, makes a distinction between production costs and post-production
costs. It is generally accepted that the production phase of oil and gas operations
11
terminates at the wellhead when the minerals are reduced to possession. See Babin v.
First Energy Corp., 96-1232 (La. App. 1 Cir. 3/27/97), 693 So.2d 813, 815. Postproduction costs are those costs and expenses incurred after the production has been
discovered and delivered to the surface of the earth. Such “subsequent to production”
costs generally include those related to taxes, transportation, processing, dehydration,
treating, compression, and gathering. See id.; see also Williams & Meyers, Manual of Oil
& Gas Terms (13th ed. 2006). While the peculiarities of individual lease provisions may
provide otherwise, the general rule is that a royalty owner is liable for a proportionate
share of the costs incurred subsequent to production. See id.
Plaintiffs allege that they bargained with Chesapeake and came to an agreement
that Chesapeake would only deduct Plaintiffs’ pro rata “portion of gross production taxes,
pipeline taxes, and all other taxes” from their ORRI. See Record Document 39 at 17.
Plaintiffs contend the phrase “all development, production, and operating expense[s]”
explicitly prohibits Chesapeake from deducting any other expenses, including those that
might be labeled “post-production costs.” See id. Conversely, Chesapeake argues that
the failure of the parties to specifically include any “post-production costs” should be
interpreted to mean that Chesapeake has a right to deduct these costs from the ORRI.
See Record Document 34 at 1. Plaintiffs believe their interpretation of the Agreement and
assignments is a reasonable one which creates ambiguity, and argues for the admission
of parol evidence, specifically the affidavit testimony of James Morgan and Charles
Martin. However, after reviewing the language of both the Agreement and assignments
the Court finds the parties unambiguously intended to share pro rata “post-production”
costs.
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Looking at the provision in question, found in Exhibits “B”-“O” (Record Document
34-3), the parties agreed the ORRI would be “free of all development, production, and
operating expense[s],” while Plaintiffs agreed to “bear and pay its portion of gross
production taxes, pipeline taxes, and all other taxes assessed against the gross
production….” Record Document 34-3 at 1. Since the provision makes no mention of any
post-production costs whatsoever, the Court finds the parties unambiguously only
intended to exclude production costs.
Plaintiffs argue the provision “free of all development, production, and operating
expense” does include post-production expenses, specifically the term “develop.” See
Record Document 44 at 3. Plaintiffs suggest the term “develop,” as defined in Broussard
v. Hilcorp Entergy Co., 09-449 (La. 2009), 24 So.3d 813, 820, “contemplates any step
taken in the search for, capture, production and marketing of hydrocarbons.”
“Development in this sense is not only the exploration for, but the exploitation of, or the
capture and marketing of, the minerals….” Waseco Chem. & Supply Co. v. Bayou State
Oil Corp., 371 So.2d 305, 307 (La. App. 2 Cir. 1979). However, as Chesapeake points
out, Waseco referred to development “in the sense” of the lessee’s duty to his lessor to
develop and operate the leased land, and not to assessments of costs. See id. If applied
in the context of the instant matter, development is “the drilling and bringing into
production of wells in addition to the exploratory or discovery well on a lease.” Williams &
Meyers, Manual of Oil & Gas Terms (16th ed. 2015), p. 258.
There is a tremendous amount of support for Chesapeake’s claim that
“development” costs are not post-production costs. In Wellman v. Energy Res., Inc., 210
W.Va. 200, 210 (2001), the court stated that, “Two states, Texas and Louisiana, have
13
recognized that a lessee may properly charge a lessor with a pro rata share of such postproduction (as opposed to production or development) costs.” Additionally, a Texas court
found development costs were production costs, as opposed to post-production costs.
See Chesapeake Expl., L.L.C. v. Hyder, 427 S.W.3d 472, 480 (Tex. App. 2014), aff'd, 483
S.W.3d 870 (Tex. 2016). In further support, a 2004 article in the West Virginia Law Review
explained expenses “included in the category of production costs are: exploration;
geological surveys; drilling; development….” R. Cordell Pierce, Making A Statement
Without Saying A Word: What Implied Covenants “Say” When the Lease Is “Silent” on
Post-Production Costs, 107 W. Va. L. Rev. 295, 308 (2004) (emphasis added). Although
not Louisiana law, the Court finds Chesapeake’s definition of “development” to be in the
correct context and on point. Therefore, the term “development,” as it is written in the
provision, does not include marketing costs, i.e., post-production costs.
Plaintiffs next contend the term “all” encompasses “each and every part of
production.” See Record Document 44 at 3. However, as previously discussed, Louisiana
makes a distinction between production and post-production costs. Therefore, Plaintiffs’
argument that each and every part of production extends to post-production costs has no
merit since production and post-production are two separate, distinct categories.
Plaintiffs finally argue the word “marketed,” found in Exhibit “B” to the Agreement
(Record Document 34-2 at 10), which in pertinent part reads, “equal to the difference
between the lease royalty and 28% of all oil, gas and casinghead gas produced, saved
and marketed from the lands covered by the lease,” coupled with the cost-free language
in the assignments illustrates that the parties intended for Plaintiffs’ ORRI to be free from
marketing, i.e., post-production, costs. See Record Document 44 at 4. However, the Court
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does not find the term “marketed” applicable to the allocation of costs. Within the context
of the provision, “marketed” refers to the gas sold by Chesapeake from the leased lands. 3
Chesapeake cites two cases to support its claim that the provision “free of all
development, production, and operating expense” does not include post-production
costs: Martin v. Glass, 571 F.Supp. 1406 (N.D. Tex. 1983), aff’d, 736 F.2d 1524 (5th Cir.
1984) and Hyder, 427 S.W.3d 472 (Tex. App. 2014), aff'd, 483 S.W.3d 870 (Tex. 2016).
In Martin, the lessee, Minerals, Inc., assigned its interest to Wes-Mor Drilling Inc. (“WesMor”) while reserving an overriding royalty interest. See Martin, 571 F.Supp. at 1410.
After drilling two producing gas wells, John Glass (a successor of Wes-Mor) charged
Minerals, Inc. for certain compression costs incurred subsequent to production. See id.
Minerals, Inc. filed suit against Glass for its portion of proceeds of productions “free and
clear of all cost of exploration, development, completion and operation….” Id. The court
went through a thorough analysis of the standard royalty provision and concluded that,
“an overriding royalty is, first and foremost, a royalty interest.” Id. at 1416. Having reached
that conclusion, the court then stated, “[T]he overriding royalty provisions provide that
said interests shall be free and clear of all costs of drilling, exploration, development,
completion and operating expenses … [c]learly, the overriding royalty clauses refer only
to costs incident to getting gas to the surface.” Id. at 1416-17. The court reasoned that
3
Plaintiffs also argue interpreting the phrase “development, production, and operating expense” to include
post-production costs is supported by Plaintiffs’ affidavit testimony regarding both the gas industry custom
in Louisiana and their own intent in entering into the relevant agreements. See Record Document 44 at 4.
However, “[w]hen the language of a contract is clear and unambiguous, it must be interpreted solely by
reference to the four corners of that document.” Dickson, 2013 WL at *3, citing Tammariello Properties, Inc,
549 So.2d at 1263. Since the Court finds the language of the agreements to be clear and unambiguous,
the Court cannot look outside the four corners of the documents. Accordingly, Plaintiffs’ affidavit testimony
will not be considered.
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since the assignments made no mention of post-production costs, the parties had not
intended to exclude them.
Chesapeake uses Hyder to illustrate the language needed to modify the default
rule. In Hyder, the overriding royalty provision read, “a perpetual, cost-free overriding
royalty.” See Hyder, 427 S.W.3d at 478. The court distinguished Hyder’s “cost-free”
language from the language in Martin “because it d[id] not limit the types of costs to be
excluded from the overriding royalty to production costs alone.” Id. at 480. “Martin
expressly limited the costs that were to be excluded from the overriding royalty to
exploration, development, drilling, completion, and operation costs—all of which are
production costs, as opposed to post-production costs.” Id.
Here, the language is much more similar to that in Martin than in Hyder. The parties
expressly limited the types of costs to be excluded from the ORRI as “all development,
production, and operating expense[s].” As discussed previously, “development,
production, and operation expense[s]” all refer to production costs, as opposed to postproduction costs. Therefore, since the provision made no mention of post-production
costs, the parties did not intend to exclude them.
Plaintiffs argue these cases are inapplicable to the instant suit because: (1) they
involve Texas law and (2) the provisions in both Martin and Hyder contain “at the well”
language – language not found in any agreement between Plaintiffs and Chesapeake.
See Record Document 44 at 5. First, although decisions of other jurisdictions are not
binding on the courts of Louisiana, they can be persuasive. See Monochem, Inc. v. East
Ascension Tel. Co., 195 So.2d 748 (La. App. 1 Cir. 1967). Louisiana courts have relied
on Texas decisions regarding the same subject matter and very similar contract
16
provisions. See Merritt, 499 So.2d at 214. In fact, the court in Martin in its ruling relied
heavily on the Fifth Circuit’s interpretation of Louisiana law in Freeland v. Sun Oil Co.,
277 F.2d 154 (5th Cir. 1960). Additionally, both states recognize the general rule that
post-production costs are shared pro rata unless a lease says otherwise. See Magnolia
Point Minerals, L.L.C., 2013 WL at *4; Martin, 571 F.Supp. at 1410.
Next, Plaintiffs argue that the provisions in both Martin and Hyder are inapplicable
because they contain “at the well” language. “At the well” determines the point of valuation
where the gas is brought to the surface, and the price of such gas is based on the value
before processing and does not include increases in value from processing or
transportation. R. Cordell Pierce, Making A Statement Without Saying A Word: What
Implied Covenants "Say" When the Lease Is "Silent" on Post-Production Costs, 107 W.
Va. L. Rev. 295, 304 (2004). Consequently, for royalties paid “at the well,” the lessors
“may be charged with processing costs ... [meaning] all expenses subsequent to
production, relating to the processing, transportation, and marketing of gas.” Id.
Here, Plaintiffs retained an ORRI of “all oil, gas and casinghead gas produced,
saved, and marketed from the lands covered by said leases.” Plaintiffs are correct that
courts do distinguish this “all products” provision from “at the well” provisions; but this
distinction does not lead to a different analysis or result. See Chesapeake Expl., L.L.C. v.
Hyder, 483 S.W.3d 870, 874 (Tex. 2016) (“Specifying that the volume on which a royalty
is due must be determined at the wellhead says nothing about whether the overriding
royalty must bear postproduction costs”).
The decision in Yturria v. Kerr-McGee Oil & Gas Onshore, LP, 2006 WL 3227326
(S.D. Tex. Nov. 6, 2006), aff'd sub nom. Yturria v. Kerr-McGee Oil & Gas Onshore, LLC,
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291 F.Appx. 626 (5th Cir. 2008), 4 is insightful. There, even though the ORRI was of “all
plant products,” the court still looked to the language of the provision to see if postproduction costs were excluded. 5 See id. at *10. The court acknowledged the defendant’s
cited case dealt with a lease containing “market value at the well” language, but still found
the case “provide[d] guidance in determining a lessee’s royalty payment.” See id. After
analyzing the “all plant products” provision together with the “post-production costs”
provision, the court found the language unambiguously excluded post-production costs
because such terms were specifically listed in the agreement. See id. at *2, *10 (“Lessor's
royalty shall never bear … any part of the costs or expenses of production, gathering,
dehydration, compression, transportation, manufacture, processing, treatment or
marketing of the oil or gas from the leased premises”) (emphasis added).
Comparing the “post-production costs” provision in Yturria with the production
costs provision in the instant matter, it is evident that Plaintiffs have failed to modify
Louisiana’s general rule. While the plaintiffs in Yturria specifically listed eight postproduction costs to be excluded, Plaintiffs here have failed to list even one. As discussed
in detail above, “development, production, and operating expense[s]” are all recognized
as production costs. Therefore, although the ORRI is subject to “all oil, gas and
casinghead gas” produced, Plaintiffs failed to modify Louisiana’s general rule when they
failed to list a single post-production cost to be excluded. As was the case in Martin, since
the assignments made no mention of post-production costs, the parties did not intend to
4 Kerr-McGee Oil & Gas Onshore, LP and Kerr McGee Oil & Gas Onshore, LLC are two separate entities
and both were lessees in this dispute. See Yturria, 291 F.Appx. at 627 (5th Cir. 2008).
5 “[T]he parties modified the general rule by agreement by requiring Defendants to pay Plaintiffs' royalty
based on ‘all’ plant products or revenue derived from the leased premises and instructing that Plaintiffs'
royalty payments ‘shall never bear’ and ‘shall not be subject’ to any costs or expenses for production,
transportation, marketing, etc.” Id. at *10 (emphasis added).
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exclude them. Accordingly, the Court finds the parties unambiguously intended to share
pro rata post-production costs.
CONCLUSION
After due consideration of the specific language used within the four corners of the
Agreement and accompanying assignments, the Court finds that the terms are clear and
unambiguous and there is no genuine dispute as to a material fact. Here, Plaintiffs
reserved ORRIs in the lands covered by the Agreement. Said ORRIs did not expressly
exclude post-production costs. Therefore, under Louisiana law, Chesapeake possessed
full contractual authority to deduct post-production costs before making royalty payments
to Plaintiffs. Accordingly, Chesapeake’s “Motion for Partial Summary Judgment” (Record
Document 34) dismissing Plaintiffs’ claims that Chesapeake improperly deducted postproduction costs is hereby GRANTED.
THUS DONE AND SIGNED in Shreveport, Louisiana, this 22nd day of March,
2018.
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