The Hyder case was argued in the Texas Supreme Court on March 24, 2015. Although Justice Raul Gonzalez filed an Amicus Brief (“Gonzalez Brief”) in the case on behalf of two groups (Texas Land and Minerals Owners Association and National Association of Royalty Owners-Texas, Inc.), little attention was given to the averments made in the brief. Unlike the principle briefs for the Hyder family, which sidestep taking on the Heritage opinion directly given the overriding royalty interest involved along with the Heritage-disclaiming language of the lease, the Gonzalez Brief does an exquisite job showing the inconsistencies in the Heritage “majority” opinion and concurrence, both internal conflicts and inconsistencies with other leading Texas oil and gas opinions applying basic contract interpretation principles to oil and gas leases. Not surprising given the lead author, the Gonzalez Brief echoes his devastating dissent in Heritage.
Recall that in Heritage then-Justice Gonzalez, joined by then-Justice Abbott, took the majority to task for ignoring the express language of the leases there in question: “[T]here shall be no deductions from the value of Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas.” Heritage Res. v. NationsBank, 939 S.W.2d 118, 120-21 (Tex. 1996). The Dissent notes: “What could be more clear?”…. “Under basic rules of contract interpretation, this Court must give effect to the written expression of the parties’ intent.” Heritage, 939 S.W.2d at 132 (explaining that when leases are unambiguous, the Court “errs by ignoring the clear intent of the parties”).
Even if the leases were ambiguous—a possibility raised by the differing interpretations of the same language by the trial court, court of appeals, “majority” and concurrence—the basic rules of contract interpretation construing the lease against the lessee results in the “no deducts” clause prevailing. Finally, the Dissent notes that the Court was for the first time interpreting the phrase “market value at the well,” and doing so by substituting its own interpretation “for the meaning the parties intended.” Id. at 133.
The Amicus Brief is even more direct, and takes on another issue injected by two recently decided Fifth Circuit cases authored by Justice Owen, essentially adopting her concurrence from Heritage. That issue: is Heritage even binding precedent? The Gonzalez Brief describes the point, as made in his dissent on motion for rehearing in Heritage: Justices Cornyn, Spector and Abbott joined him in voting to grant re-hearing in Heritage. Justice Enoch had recused himself, and Justice Phillips as switched his vote to the concurrence, leaving only Justice Baker as the “lone remaining supporter of his original majority opinion.” Heritage Res. v. NationsBank, 690 S.W.2d 619, 620 (Tex. 1997). This left the Court equally divided. “Because we are without a majority agreement on the reasons supporting the judgment…the judgment itself has very limited precedential value and controls only this case.” Id. (citations omitted).
Perhaps anticipating this issue could well come up again, former Justice Owen, now on the Fifth Circuit Court of Appeals, addressed the precedential value of Heritage in Potts:
The lessors contend that the district court erred by relying on Heritage, asserting that the case has limited precedential value. They note that after the opinion in Heritage issued, one of the Justices who had joined the majority opinion recused himself. The other members of the Supreme Court of Texas split 4–4 in ruling on a motion for rehearing. An opinion dissenting from the denial of rehearing reflects that two of the Justices who had originally joined the majority opinion had changed position and had expressed their agreement with the original dissenting opinion. The lessors argue that the Texas court was thus without a majority that agreed on the reasons supporting the judgment in Heritage.Because rehearing was denied, the court's opinion in Heritage was not withdrawn. The Texas court's decision in Heritage remains binding law, as the numerous cases from both the Supreme Court of Texas and this court citing that decision demonstrate.
Potts v. Chesapeake Exploration, LLC, 760 F.3d 470, 473 (5th Cir. 2014) (emphasis added, footnote omitted). But even a cursory comparison of Judge Owen’s citations (in footnote 23) for the proposition that Heritage is valid binding precedent, to Justice Gonzales’ citations that it is not, shows his cases are actually on point, while hers are not.
Another striking aspect of the Gonzalez Brief is the marshalling of the numerous examples of the abuses of the “net-back-to get-to-market-value” approach Heritage was seen to license, at least as done by Chesapeake. Several producers now sell gas at the wellhead to affiliate companies. While this might perhaps theoretically be done in a way that doesn’t harm the royalty owner, in practice the lack of arms’ length negotiation of wellhead price has apparently fostered a plethora of abuses on the deduction side. Even then-Justice, now Judge, Owen’s repeated statement that those deductions must be “reasonable” has not slowed down the abuses of the post-production deduction regime.
The focus on the oral argument was the nature of an ORRI. Counsel for Chesapeake argued that, unlike other royalty interests, an ORRI is not free of production costs because it is carved out of the working interest, which must pay for producing the minerals from the land. Counsel for Chesapeake then stated that because the language of the lease stated that the overriding royalty shall be “cost-free,” the parties intended the ORRI to be free of production costs. Counsel stated that the Heritage disclaimer did not apply to the ORRI because the disclaimer was only included in the royalty clause and it modified the list of post-production costs that were excluded from the Hyder’s royalty. See Chesapeake Exploration, L.L.C. v. Hyder, 427 S.W.3d 472, 479 (Tex. App.—San Antonio 2014, pet. granted) (the disclaimer provides that “. . . the holding in the case of Heritage Resources, Inc. v. NationsBank . . . shall have no application to the terms and provisions of [the Hyder lease].”). Therefore, Counsel or Chesapeake argued that the ORRI was free of post-production costs but subject to post-production costs.
This argument is quite strange because a royalty, by definition, is free from post-production costs, but subject to post-production costs. Even Heritage opinion stated that a royalty interest was free of production costs but subject to post-production costs. See Heritage, 939 S.W.2d at 121-22 (“Royalty is commonly defined as the landowner's share of production, free of expenses of production. . . . Although it is not subject to the costs of production, royalty is usually subject to post-production costs . . .”). Pursuant to Texas law, an ORRI is not a carried working interest and is not chargeable with production costs. See Paradigm Oil, Inc. v. Retamco Operating, Inc., 372 S.W.3d 177, 180 n. 1 (Tex. 2012); see also Alamo Nat'l Bank of San Antonio v. Hurd, 485 S.W.2d 335, 339 (Tex. App.—San Antonio 1972, writ ref'd n.r.e.) (“The term ‘overriding royalty’ as used in an oil and gas lease means a given percentage of the production carved from the working interest, but by agreement, not chargeable with any of the expenses of operation.”).
The parties failed to mention that the ORRI was “cost-free” except for severance taxes. See Hyder, 427 S.W.3d at 478 (“. . . cost-free (except only its portion of production taxes) overriding royalty . . .”). These severance taxes are normally charged to the working interest owner once it produces oil, gas or other minerals from the beneath the surface of the land. The express allowance of severance taxes in the oil and gas lease would seem to negate other post-production deductions from the Hyder’s royalty.