Oil and Gas Update

Fixed or Floating? Another Texas Case Tackles Interpreting NPRIs

    A Texas court of appeals recently issued a decision construing the reservation of a nonparticipating royalty interest (NPRI) in a deed and resolving a dispute concerning the nature and calculation of such NPRI.  The case, Hoffman v. Thomson[1], is another example of the “fixed” vs. “floating” royalty line of Texas cases, which has become an area of frequent litigation in the oil and gas arena, and is one in a recent line of such cases in which the court had to assess the impact of the parties’ inclusion of a double fraction in the deed.

    A fixed royalty is a fixed fraction of the total production.  A floating royalty refers to a fraction of the entire royalty interest, meaning the total amount the NPRI owner receives depends on the royalty rate negotiated in the lease.  Confusion arises with double fractions.  For example, does “1/2 of the 1/8 royalty” result in a fixed 1/16 royalty or a floating 1/2 royalty?

Recent Cases

    Before discussing Hoffman, a brief recap of recent decisions is useful in framing the case.

 Hysaw v. Dawkins[2]

             In this 2016 case from the Supreme Court of Texas, a woman’s 1946 will left each of her three children a NPRI of “an undivided one-third (1/3) of an undivided one eighth (1/8) of all oil, gas or other minerals in or under that may be produced from any of said lands.”[3]  This language created an issue of whether the double fraction reserved a fixed 1/24 royalty or a floating 1/3 royalty.  The Court found this was a floating 1/3 royalty for a variety of reasons.  It made sense that three children would be given equal 1/3 shares, the standard royalty at the time the will was drafted was 1/8, and a fixed interest would create disharmony among deed language.

U.S. Shale Energy II, LLC v. Laborde Properties, L.P.[4]

            The Supreme Court of Texas dealt with a case very similar to Hysaw in 2018.  Here, a 1951 deed reserved “an undivided one-half (1/2) interest in and to the Oil Royalty, Gas Royalty and Royalty in other Minerals in and under that  may be produced or mined from the above described premises, the same being equal to one-sixteenth (1/16) of the production…”[5]  Again, this was found to be a floating royalty based on the standard 1/8 royalty of the time, “…the same being equal to one-sixteenth…” serving as clarifying language to the calculation, and the 1/2 interest being tied to the royalty rate.

Five Star Royalty Partners Ltd. v. Mauldin[6]

             The Fifth Circuit answered another question about a deed containing floating royalties in this 2020 decision.  The confusion stemmed from a 1927 deed conveying a “royalty interest of three-eighths (3/8) of all … minerals…” which also included the clauses, “the royalty interest hereby conveyed is a three-eighths (3/8) part of the royalty provided by said lease to be paid…” and “three-eighths of one-eighth interest… is a royalty interest only…”  In determining whether this was a fixed 3/64 royalty or a floating 3/8 royalty, the court looked to factors such as the usual 1/8 royalty during that era, the deed did not relieve the grantee of the requirement to pay production costs, and the previous lease with a 1/8 royalty terminated.  The court held this was a floating 3/8 royalty, resulting in a victory for the royalty interest owners, who were represented by Thompson & Knight attorneys.

Van Dyke v. Navigator Group[7]

            This late 2020 decision comes from another Texas court of appeals.  The court found a fixed 1/16 NPRI existed.  The deed reserved a “one-half of one-eighth of all minerals and mineral rights,” and this figure was the only mention of the size of an interest.  The court determined the language in the deed to be unambiguous, since there was no other language used to describe the reservation, thus creating a fixed 1/16 reservation.

            All of the above cases (particularly Hysaw and U.S. Shale Energy II) show a trend of a holistic approach in deed interpretation, rather than a mechanical approach.  Hoffman continues to follow this trend.

Hoffman v. Thomson

             In 1956, the Hoffmans conveyed a tract of land to Peeler and reserved “an undivided three thirty-second’s (3/32’s) interest (same being three-fourths (3/4’s) of the usual one-eighth (1/8th) royalty) in and to all of the oil, gas and other minerals, in to and under or that may be produced from the land herein conveyed…”[8] Both parties argued the deed was unambiguous, with the Hoffmans asserting the deed reserved an undivided floating 3/4 royalty and the Peelers claiming the deed only reserved a fixed 3/32 NPRI.  The parties did not dispute any facts; this was purely a deed construction case.  The trial court sided with the Peelers and construed the deed to reserve a fixed 3/32 NPRI.

            Before beginning its interpretation, the court laid out a few basic deed construction principles that it stated guided its analysis.  Continuing in the line of cases discussed above, the court placed particular emphasis on the fact that at the time when the deed was written in 1956, a 1/8 royalty was considered “standard and customary.”[9]

            Ultimately, the court honed in on three clauses contained in the deed, which read as follows:

Clause 1          “There is hereby expressly reserved… an undivided three thirty-second’s (3/32’s) interest (same being three-fourths (3/4’s) of the usual one-eighth (1/8th) royalty) in and to all of the oil, gas and other minerals…”

Clause 2          “Hoffman … shall receive a full three thirty-second’s (3/32’s) portion thereof as his own property…”

Clause 3          “Hoffman, shall own and be entitled to receive three thirty-second’s (3/32’s) of the gross production of all oil, gas and other minerals produced and saved…”

The court noted that, read in isolation, the latter two clauses would likely establish a fixed royalty interest.  Clause 3, for example, appears to expressly require that the owner be entitled to three thirty-seconds (3/32’s) of the “gross production.”  However, the court stated it “must give effect to, and harmonize, all the language, even if the second and third clauses might initially appear inconsistent or contradictory to the entire first clause.”[10]

When harmonizing the language, the court noted again that the “same being three-fourths (3/4’s) of the usual one-eighth (1/8) royalty” was consistent with the usual 1/8 royalty of that time, meaning the Hoffmans kept a 3/32 interest, or 3/4 of the royalty, whatever that royalty may actually be under the relevant lease at issue.  Thus, the court concluded, when 3/32 is used in the later clauses, it was used as “a placeholder or shorthand” for the full 3/4 of the royalty.[11]  According to the court when 3/32 is replaced with “three-fourths of the royalty” in later clauses, the “substitution also gives full effect to the language in all three clauses and does not create any conflicts or render any provision meaningless.”[12]  If the deed reserved only a 3/32 interest, the “same being three-fourths … of the usual one-eighth royalty” language would be both meaningless and create a conflict if the royalty was anything besides 1/8.  In continuing to follow the trend of holistic interpretation, the court determined the deed established a floating 3/4 royalty interest, reversing the trial court’s decision.

Current Status

            On March 24, 2021, a motion for extension of time to file motion for rehearing was granted.

Download Hoffman v. Thomson

 

Anna Boyer

Thompson & Knight, LLP

 

[1] No. 04-19-00771-CV, 2021 WL 881286 (Tex. App.—San Antonio Mar. 10, 2021, no pet. h.). 

[2] 483 S.W.3d 1 (Tex. 2016).

[3] Id. at 2.

[4] 551 S.W.3d 148 (Tex. 2018).

[5] Id. at 150.

[6] 973 F.3d 367 (5th Cir. 2020).

[7] No. 11-18-00050-CV, 2020 WL 7863330 (Tex. App.—Eastland Dec. 31, 2020, no pet. h.).  On March 12, 2021 a Second Motion for Extension of Time to File Petition for Review was granted.

[8] Id. at *1.

[9] Id. at *3 (citing Hysaw, 483 S.W.3d at 9).

[10] Id. at *4.

[11] Id. at *6.

[12] Id.

Property Subject to an Oil and Gas Mechanics and Materialmen's Lien

    The last blog post discussed the initial considerations in determining whether an oil and gas service or material provider is entitled to a Texas statutory lien (an “M&M Lien”) to secure amounts owed to the provider. The key is whether the provider performed labor or provided materials in a mineral activity either directly or indirectly to a mineral property owner.

    If the initial hurdles are satisfied, then the question is what property will be subject to the lien. Not surprisingly, the M&M Lien attaches to all materials, machinery and supplies that a provider furnished or handled. The M&M Lien also attaches to each of the following for which the lien claimant provided services or materials:

• land;
• leasehold;
• oil or gas well or water well;
• oil or gas pipeline and its right-of-way.

    An M&M Lien that attaches to a leasehold estate covers not only the well on which the claimant provided services or materials but also all other wells located on the leasehold in which the mineral property owner owns an interest. For example, if there are six producing wells on a lease, the mineral property owner drills a seventh well on the lease and fails to pay the drilling contractor, all seven wells will be subject to the contractor’s M&M Lien.

    An M&M Lien does not attach to property for which a service provider did not provide services or materials. As an example, Mr. Jones, who is a mineral property owner contracts with Mr. White, a drilling contractor, to drill three wells located on three separate tracts of land that are not operated as a unit. Mr. Jones pays Mr. White for services performed for two of the wells but not the third. Mr. White will be able to secure an M&M Lien only on the well for which he has not been paid and the tract of land on which such well is located. Even though Mr. White’s contract with Mr. Pink covered all three tracts of land, because they are separate tracts not operated as a unit, Mr. White cannot claim an M&M Lien on the two tracts for which he has received payment.

    An M&M Lien attaches only to the interests of mineral property owners who are parties to the contract. So, if Mr. Pink is an operator who holds only a one percent working interest in the well drilled by Mr. White, Mr. White can secure an M&M Lien only on Mr. Pink’s one percent interest.

    A service provider’s claim for payment for services or materials provided before a mineral property owner assigns all or a portion of its interests to a third party may burden the assignee’s interest. For example, assume that Mr. Pink owns 100% of a leasehold at the time Mr. Pink and Mr. White enter into a contract for drilling on the lease. After Mr. White performs the services, Mr. Pink assigns twenty-five percent of his interest in the lease to Mr. Green. Mr. White then files to secure an M&M Lien on the well and the lease. Mr. White would not be obligated to give notice of the lien to Mr. Green because he had contracted with Mr. Pink before the assignment, and Mr. Green’s interest would be subject to the lien.

    The Texas statutory lien does not attach to proceeds of oil and gas production. Courts have generally been unwilling to expand the coverage of the lien to property not listed or described in the statute. Nevertheless, in 1997, an appellate court upheld an appointment of a receiver to take possession of the proceeds from production prior to the foreclosure of the M&M Lien. The court held the action necessary to protect the lienholder because production was diminishing the lienholder’s collateral. The court did not address the previous line of cases holding that M&M lien claimants were not entitled to proceeds of production.

    To be able to take advantage of the protection afforded by the Texas statutory M&M Lien, a service provider must properly secure the lien. The next blog post will set forth the necessary steps.

Protecting Oil and Gas Service Providers

    Some legal topics are cyclical in nature.  The topics lay dormant until an economic change makes them relevant.  One of the most cyclical topics is the Texas statutory oil and gas lien available to service and material providers.  When oil prices hovered around $100 per barrel, providers to the energy industry were not overly concerned about protecting their rights to payment.  After the oil price collapse and continued doldrums, the topic of oil and gas mechanic's and materialmen's liens has once again become relevant. 

    Over the next few blog posts, we will discuss (i) who is entitled to a mechanic's and materialmen's lien ("M&M Liens"), (ii) what property may be subject to an M&M Lien, (iii) how an M&M lien is secured, and (iv) how a lienholder enforces an M&M Lien.  To understand M&M Liens, one must first understand who is entitled to utilize the statutory protection.

    Chapter 56 of the Texas Property Code provides statutory liens for persons who provide services or materials in the drilling, operation or maintenance of a well.  One of the key definitions is that of a "mineral property owner."  Section 56.001(3) of the Texas Property Code defines a "mineral property owner" as someone who is an owner of:

• land;
• oil, gas or other mineral leasehold;
• oil and gas pipeline; or
• oil or gas pipeline right of way.

Only persons who have provided services or materials, either directly or indirectly, to a mineral property owner can claim an M&M Lien.

    A provider who contracts directly with a mineral property owner for the provision of services or materials in mineral activities constitutes a "mineral contractor" under the M&M Lien statute.  A "mineral subcontractor," on the other hand, is anyone who:

• furnishes materials or performs labor used in mineral activities under a contract with a mineral contractor or another subcontractor, or
• performs labor in mineral activities as an artisan or day laborer employed by a subcontractor.

Whether a person is a contractor or subcontractor depends on the person's relationship with the mineral property owner at the time of contracting.  The classification of a provider as a contractor or subcontractor is important because the necessary steps to secure an M&M Lien vary depending on the relationship between the provider and the mineral property owner.

    The services or materials provided to a mineral property owner must constitute "mineral activities"  Section 56.001(1) of the Texas Property Code defines "mineral activities" as:

• digging, drilling, torpedoing, operating, completing, maintaining or repairing
• an oil, gas or water well, an oil and gas pipeline or a mine or quarry. 

In general, any activity that helps facilitate the potential production of oil and gas will constitute a "mineral activity."

    Even though the definition is broad, courts have found that the following activities do not constitute mineral activities:

• dismantling and removing an underground pipeline;
• creation of business plans for a pipeline;
• preparation of gas contracts; and
• costs for repairs to rental equipment, unless the mineral owner caused the damage.

It is not a requirement that the services provided include physical labor on the mineral property.  Courts have found a range of services to be essential to the production of oil and gas and, therefore, entitled to an M&M Lien.  Examples of such services are:

• catering services to an offshore rig;
• plumbing work incorporated into the living quarters of an offshore platform; and
• rentals of equipment or casing.

    To recap, the initial step in analyzing whether or not an M&M Lien can be secured is to determine whether the services or materials were provided to a mineral property owner in a mineral activity.  The next blog post will discuss what property may be subject to an M&M Lien.

 

Debra J. Villarreal

Thompson & Knight LLP

 

 

 

A Global View of Upstream Law

Andy Derman and I recently co-authored a chapter for Upstream Law and Regulation:  A Global Guide.  Our chapter addresses regulatory frameworks in the states of Louisiana, North Dakota, Oklahoma, Pennsylvania and Texas.  The other chapters in the book summarize oil and gas regulations in thirty-two countries in Africa, Latin America, Europe, the Middle East, Asia and the Pacific. The book highlights how relatively new types of resources – unconventional oil and gas – have led to new regulatory frameworks being adopted in countries not traditionally known as petroleum producing countries, such as Poland. 

It is evident that shale gas has triggered dramatic changes in the industry worldwide.  Not only are industry standard documents, such as joint operating agreements, being modified to address unconventional plays but national laws around the world are also being revised or enacted to deal with the new production. 

When we look internationally, we see how the range of responsibilities and roles of national oil companies are also evolving.  Some national companies are active in international markets and act
either as an arm of the country or as an international company in the industry.   The Chinese national companies seem particularly active. 

 As the editors of Upstream Law and Regulation, Eduardo G. Periera and Kim Talus, point out, China is an interesting example because it has several national companies that have differing roles in the industry.  China National Petroleum Corporation (CNPC) is China’s largest oil and gas producer and is also a major oilfield and engineering services provider.  Sinopec is the largest integrated petroleum and petrochemical company and is the largest refined oil producer in China.  CNOOC Limited is an upstream company and is the dominant oil and natural gas producer in offshore China.  Under Chinese laws, CNOOC is responsible for negotiating with foreign partners in offshore upstream activities.  CNPC and Sinopec both have the right to negotiate contracts with foreign partners in onshore upstream endeavors.  Of course, all three of the Chinese national oil companies have acquired reserves in North America in recent years. 

The book reflects how the ownership of oil and gas in the United States remains very different from ownership in the rest of the world.  Only the United States and certain parts of Canada allow for individual ownership of minerals.  Elsewhere, the ownership of petroleum reserves is either shared among the people of a country or rests with the state, with the resources then being managed by the state or a national oil company on behalf of the state.    

You can view the book's index at  http://www.globelawandbusiness.com/ULR/ to see the emerging oil and gas jurisdictions covered by the book.

Debra Villarreal, Thompson & Knight LLP

 

Oilfield Lingo: Don’t Let a ‘Carry’ Become a Costly Burden

Oilfield lingo can be confusing even for seasoned E & P professionals. Interpretations of commonly used words can be as varied as grades of crude oil. When it comes to partnership agreements, unless you clearly define these terms upfront, you may find yourself in a dispute later. 

 Take for instance, the term carry. When a working interest owner, one who has a percentage of ownership in an oil and gas lease, is involved with the development of the prospect, the other partners may grant them a carry. This means the other partners will carry them, paying all or part of his or her share of the costs involved in the prospect.

 A carry reduces the cash the developing partner needs initially to obtain an interest. While this can be a great way to secure a deal, it’s important for every working interest owner involved in the partnership to know exactly what costs you intend the carry to cover.

 If you are contemplating a deal that includes a carry, consider setting some guidelines on what exactly it entails:

     (i)      Is the carry for a certain number of wells or for a set dollar amount?

    (ii)     Will the carry be only for drilling and completion costs or will it also cover the construction of gathering lines? 

    (iii)    Will the carry cover leasing and land costs?

    (iv)    If the carry includes completion costs, how will the parties define “completion”?

    (v)      Is the carry to be used in a certain period of time?

    (vi)    Can the carry be assigned to someone else? 

By defining the carry and setting the ground rules upfront, you may avoid both unpleasant misunderstandings and costly legal disputes.

 

Debra Villarreal -- Thompson & Knight LLP