HERITAGE RESOURCES, INC. v. NATIONSBANK No. 95-0515.
939 S.W.2d 118 (1996)
HERITAGE RESOURCES, INC., Petitioner, v. NATIONSBANK, Co-Trustee under the Will of David B. Trammell, Deceased et al., Respondents.
Supreme Court of Texas.
Rehearing Overruled March 21, 1997.
John R. Woodward, Dallas, for Petitioner.
Robert Scogin, Kermit, Rick K. Disney, Fort Worth, Cary L. Jennings, Fort Worth, Ben A. Douglas, Fort Worth, for Respondents.
Justice BAKER delivered the opinion of the Court, in which Chief Justice PHILLIPS, Justice CORNYN, Justice ENOCH, and Justice SPECTOR join.
This case involves construction of royalty clauses in several oil and gas leases. NationsBank sued Heritage contending that Heritage deducted transportation costs from the value of NationsBank's royalty in violation of the leases.
The trial court rendered a partial summary judgment against Heritage deciding liability and damages through 1991. NationsBank amended its pleading to include Heritage's deductions through 1993. After a bench trial, the trial court awarded NationsBank and other royalty owners the transportation costs Heritage deducted plus interest and attorney's fees.
The court of appeals affirmed the trial court's judgment.
We conclude the trial court and the court of appeals incorrectly interpreted the royalty clauses. We reverse the court of appeals' judgment. We render judgment that NationsBank take nothing. Further, we disapprove of the court of appeals' language about the liability of an operator who underpays royalty interest owners.
NationsBank is the trustee for owners of interests in gas, oil, and other minerals inherited under David B. Trammel's will. Heritage is the lessee and operator under a number of leases. Heritage also owns an undivided working interest in some of the leases. Heritage sold gas off the leased premises. Heritage deducted the cost to transport the gas from the wellhead to the point of sale as a post-production cost from the sales price before calculating royalties.
In January 1989, NationsBank noticed that Heritage was deducting severance taxes and transportation charges from the purchase price. NationsBank objected to the transportation charge deduction. NationsBank contended that the leases specifically prohibited the deduction. Three different leases are in issue. The relevant parts are:
Although the court of appeals states that the leases are virtually identical, the first lease is distinctly different from the others. In the first lease, for gas sold on the lease, royalty is on proceeds, with no deduction for marketing costs, but if sold at a point off the lease, the royalty is the market value at the well. However, this difference is irrelevant for purposes of this opinion. All three leases require us to determine if Heritage improperly deducted transportation costs from the royalty payments. The critical clause in all three leases is the requirement that Heritage pay the royalty interest owners their fractional interest of "the market value at the well" of the gas produced.
Royalty Clause Construction
Heritage contends that the royalty clauses define the lessor's royalty as a fraction of the market value at the well. Therefore, the clauses limiting deduction from the value of the lessor's royalty simply means that Heritage cannot deduct an amount from the sales price that would make the royalty paid less than the required fraction of market value at the well. Because NationsBank concedes Heritage only deducted reasonable transportation costs from the market value at the point of sale, Heritage did not make a deduction from the "value of the Lessor's royalty."
The court of appeals rejected Heritage's interpretation of the royalty clause. 895 S.W.2d at 836. The court of appeals reasoned that because royalty interests are normally subject to post-production costs, Heritage's interpretation renders the post-production clause meaningless. 895 S.W.2d at 837. Although we do not disagree with the court of appeals' reasoning in this respect, we find that applying the trade meaning of royalty and market value at the well renders the post-production clauses surplusage as a matter of law.
(a) Applicable Law
Oil and Gas Lease Construction
The question of whether a contract is ambiguous is one of law for the court. R & P Enters. v. LaGuarta, Gavrel & Kirk, Inc.,
Royalty is commonly defined as the landowner's share of production, free of
Market Value at the Well
Market value at the well has a commonly accepted meaning in the oil and gas industry. See generally Wakefield, Annotation, Meaning of, and Proper Method for Determining, Market Value or Market Price in Oil and Gas Lease Requiring Royalty to be Paid on Standard Measured by Such Terms, 10 ALR 4TH 732 (1981). Market value is the price a willing seller obtains from a willing buyer. See Exxon Corp. v. Middleton,
The most desirable method is to use comparable sales. Middleton, 613 S.W.2d at 246; Texas Oil & Gas Corp. v. Vela,
Courts use the second method when information about comparable sales is not readily available. See, e.g., Le Cuno Oil Co. v. Smith,
(b) Application of Law to the Facts
The court of appeals disregarded the generally accepted meanings of "market value at the well" and "royalty" to determine that Heritage wrongfully deducted post-production costs. The court of appeals' construction results in a royalty clause that specifies royalty payable as a fraction of the market value at the well, to mean the royalty is payable as a fraction of the market value at the point of sale with no deductions for post-production costs.
The terms "royalty" and "market value at the well" have well accepted meanings in the oil and gas industry. The post-production clauses in issue here plainly state that there "shall be no deduction from the value of the Lessor's Royalty." The leases clearly set the lessor's royalty as a fraction (¼ or 1/5) "of the market value at the well." Under the leases, the lessee must determine the value of the lessor's royalty. The lessee accomplishes this by determining market value at the well and multiplying it by the fraction specified in the royalty clause (¼ or 1/5). This result is the value of the lessor's royalty. The post-production clauses then specify that there can be no deduction from this value (the value of the lessor's royalty) by reason of any post-production costs.
Here, the only conclusion we can draw is that the post-production clauses merely restate existing law. The post-production clauses illustrate that the lessee cannot pay the lessor less than his fractional value of the comparable sales price (market value). This could occur if the amount realized from the
We recognize that our construction of the royalty clauses in two of the three leases arguably renders the post-productions clause unnecessary where gas sales occur off the lease. However, the commonly accepted meaning of the "royalty" and "market value at the well" terms renders the post-production clause in each lease surplusage as a matter of law.
To determine if Heritage correctly paid royalties under the leases, we must first determine the market value of the gas at the well. NationsBank offered no evidence of comparable sales. However, Heritage conceded in its response to NationsBank's motion for partial summary judgment that the price Heritage received for the gas was the market price at the point of sale. Nations-Bank conceded at oral argument that the transportation costs Heritage deducted were reasonable.
Because there is no evidence to support the comparable sales method of computing market value at the well, we use the alternate method. Under that method, Heritage must pay a royalty based on the market value at the point of sale less the reasonable post-production marketing costs. Hagen, 683 S.W.2d at 28. Based on the parties' concessions, the amount Heritage paid is the correct amount in royalties to NationsBank under the leases.
Heritage entered into division orders with the royalty owners. The division orders contained the following language:
The court of appeals held that the division orders were of no effect and that Heritage was liable for reimbursement to the royalty owners for transportation costs improperly withheld in payment to Urantia. The court of appeals' discussion about the effect of a division order that contradicts the lease terms conflicts with our earlier opinion in Gavenda v. Strata Energy, Inc.,
The general rule is that division orders are binding until revoked. Gavenda, 705 S.W.2d at 691; Middleton, 613 S.W.2d at 250. When an operator prepares a division order that allocates payments among the interest owners in a manner that differs from the lease provisions and the operator retains the benefits, the division order is not binding. Gavenda, 705 S.W.2d at 692. The basis of this rule is unjust enrichment. Gavenda, 705 S.W.2d at 692. The operator then becomes liable for the part of the interest owner's payments the operator retained. See Gavenda, 705 S.W.2d at 693. The operator is not liable for the amounts it paid out to other interest owners. Gavenda, 705 S.W.2d at 693.
The court of appeals decision incorrectly states that "Heritage was liable for reimbursement to the royalty owners for transportation costs improperly withheld in payment to Urantia." 895 S.W.2d at 839. Under Gavenda, Heritage would be liable, if at all, only for the amount of the unpaid royalty it retained. In this case, there were other working interest owners who were not parties to the suit. Absent an agreement
In conclusion, we hold that the court of appeals erred in holding that the lease required Heritage to pay royalties based on the market value at the point of sale. Further, we specifically disapprove of the court of appeals discussion about an erroneous division order's effects. We reverse the court of appeals' judgment and render judgment that NationsBank take nothing from Heritage.
Justice OWEN, joined by Justice HECHT, concurring.
I concur in the judgment of the Court. The meaning of "market value at the well," upon which the resolution of this case ultimately turns, is not as clear-cut as the Court's opinion indicates when determining whether post-production costs are to be shared by a royalty owner. I write separately to consider the meaning of "market value at the well" more fully and to recognize that the construction we are compelled to give to the leases at issue may not comport with the subjective intent of at least some of the parties to those agreements.
NationsBank, as trustee, is an owner of royalty interests under six leases that are the subject of this suit. Heritage is a working interest owner under each of the leases and is the operator of the wells located on those leases. The specific lease provisions that have given rise to this dispute are set forth in the Court's opinion.
The royalty clauses in contention specifically address marketing costs that may be incurred after the gas leaves the wellhead, including processing, dehydration, compression, and transportation costs. These are sometimes called post-production costs. The only costs at issue in this suit, however, are transportation charges. Simply put, the issue is how the cost of transporting the gas to market is to be allocated under the terms of these leases. This is a question of law. There are no factual disputes. NationsBank has conceded that the transportation charges were reasonable and in line with market rates. Heritage and NationsBank agree that the prices at which the gas was sold reflected its market value at the point of sale. It is undisputed that the sales of gas at issue have taken place off of the leased premises. The trial court, the court of appeals, and this Court correctly concluded that none of the leases are ambiguous.
At the outset, it is important to note that we are construing specific language in specific oil and gas leases. Parties to a lease may allocate costs, including post-production or marketing costs, as they choose. See generally 3 WILLIAMS, OIL & GAS LAW § 645 (1990). Our task is to determine how those costs were allocated under these particular leases.
Each of the royalty provisions begins with the statement that royalties are to be paid on gas sold off the lease based on the market value of the gas at the well. The proviso that follows, prohibiting the deduction of marketing costs from the value of the royalty, is virtually identical in all of the leases. Accordingly, any differences among the leases are immaterial for purposes of determining the royalty obligation.
The starting point in construing the leases is the language chosen by the parties. We first must ascertain the meaning of "market value at the well," which the agreements set
A number of courts in producing states across the country have considered the meaning of various royalty clauses, including "market value at the well" clauses, in deciding which marketing costs, if any, are to be borne by the royalty owner. The decisions, including those under Texas law, are not uniform. There are two diverse viewpoints, with some decisions picking and choosing between the two, depending on the specific marketing cost under consideration.
In examining decisions in this area, it must be borne in mind that not all royalty clauses were created equal. Some are based on "proceeds," some on "amount realized," while others are based on "market value." Some specify the point at which the value of the royalty is determined, such as "at the well." Some do not. Some leases have more than one method for valuing royalty depending on whether the gas is sold or used off the leased premises or is sold at the well. Different courts have accorded differing meanings to the same language.
With these distinctions in mind, I consider Texas decisions first.
The concept of "market value" is well-established in our jurisprudence. It is what a willing buyer under no compulsion to buy will pay to a willing seller under no compulsion to sell. See, e.g., Exxon Corp. v. Middleton,
In Middleton, we considered when gas is sold within the meaning of a royalty clause based on "market value at the well." Exxon contended that the gas was sold at the time Exxon entered into a long term contract with the purchaser, and that market value should be determined as of then. We disagreed, holding that market value is determined at the point in time when the gas is actually produced and delivered. 613 S.W.2d at 245. We also concluded that "sold at the wells" means sold at the wells within the lease, not sold at wells within the field. Id. at 243.
We had occasion to consider whether an operator owes a duty to a non-participating interest owner to process gas in Danciger Oil & Refineries, Inc. v. Hamill Drilling Co., 141 Tex. 153, 171 S.W.2d 321 (1943). We determined that the operator was not obligated to process the gas where the agreement provided that an overriding royalty interest would be computed on 1/24th of the gas "produced, saved and marketed at the prevailing market price paid by major companies... free and clear of operating expenses." Id., 171 S.W.2d at 322-23. The only market in the vicinity was for processed
We have recognized that for occupation tax purposes, the market value of processed gas is measured as to all ownership interests, including royalty interests, by the total proceeds of the sale of the component parts of the gas after processing, less transportation and processing costs. Mobil Oil Corp. v. Calvert,
But these decisions do not directly answer the question of who bears marketing costs under a "market value at the well" royalty clause in a lease. Our Court has spoken to this issue only obliquely. In Upham v. Ladd, 128 Tex. 14, 95 S.W.2d 365, 366 (1936), we concluded that a lessor suing for underpayment of royalties based on a clause calling for payment of "proceeds" had stated a cause of action, but noted that the question of construction of the lease was not yet before the Court.
Decisions of the courts of appeals and other courts applying Texas law have confronted the question of whether post-production costs may be allocated to the royalty interest owners, but the holdings are not entirely consistent and construe differing provisions.
One of the earliest decisions dealing with Texas law on the subject of marketing costs and payment of royalties was Phillips Petroleum Co. v. Bynum,
At least two decisions from Texas courts of appeals are at odds with the approach taken by the Fifth Circuit. The royalty in Miller v. Speed,
In contrast, other Texas courts of appeals have allowed certain marketing costs to be allocated to the royalty owner. Only one of those cases dealt with a market value royalty clause, Texas Oil & Gas Corp. v. Hagen,
Marketing costs were also charged to the royalty owners in Le Cuno Oil Co. v. Smith,
To add another point of view on this subject, a Texas court of appeals recently held that a royalty clause based on "market value at the well" was ambiguous. That court upheld a jury finding that the parties did not intend to allow the deduction of compression charges from royalties. Judice v. Mewbourne Oil Co.,
While it is fair to say that the greater number of courts considering Texas law have permitted allocation of post-production costs to royalty owners, there are decisions reaching the opposite conclusion. It remains for this Court to determine whether "market value at the well" includes or excludes post-production costs. Decisions from other jurisdictions illuminate the arguments on both sides of the issue and offer a variety of potential resolutions.
One of the most comprehensive discussions of "market value at the well" royalty clauses is Judge Wisdom's decision in Piney Woods Country Life Sch. v. Shell Oil Co.,
It has not been followed, however, by the highest courts of some of our sister states. The implied obligation to market gas was held to be paramount in Garman v. Conoco, Inc.,
The Oklahoma supreme court, after similarly surveying other states' decisions, concluded that the implied duty to market gas is a duty to "get the product to the place of sale in marketable form." Wood v. TXO Prod. Corp.,
The majority in Wood v. TXO distinguished that court's prior decision in Johnson v. Jernigan,
Kansas courts have also seemed to draw a distinction between sales on the lease premises and those off the premises in deciding whether marketing costs may be passed on to the royalty owner. Language in the lease specifying that royalty is to be determined "at the well" has not appeared to be a factor in the courts' decisions. Compare Schupbach v. Continental Oil Co.,
Arkansas seems to recognize a distinction between royalty based on "proceeds" versus "market value at the well," even if the proceeds are to be determined "at the well." Compare Hanna Oil & Gas Co. v. Taylor,
California law appears to allow the deduction of marketing costs under a "market price at the well" clause, absent language to the contrary. Atlantic Richfield Co. v. State,
The North Dakota supreme court took a route similar to that of our court of appeals in Judice. West v. Alpar Resources, Inc.,
Finally, courts applying Louisiana law have uniformly held that post-production costs are deductible under a "market value at the well" clause, commencing with the Louisiana supreme court's decision in Wall v. United Gas Pub. Serv. Co., 178 La. 908, 152 So. 561, 564 (1934) (market price means market value in the field and the lessee is not required to bear all the expense of carrying gas to a market beyond the field). Louisiana has applied a "reconstruction" approach to determine market value. Value is "reconstructed" by beginning with the gross proceeds from the sale of the gas and deducting any costs of taking the gas from the wellhead to the market. See Merritt v. Southwestern Elec. Power Co.,
Having canvassed the law of other states, it can fairly be said that there is no consensus among other jurisdictions as to when post-production costs are to be shared by the royalty owner, although the majority view appears to be that royalty owners do share in costs, at least where the sale occurs off the lease.
In the case before us, the court of appeals concluded that "market value at the well" meant that the royalty interests were subject to costs incurred after production, including taxes, costs of treating the gas, and costs of transportation to market, unless other language in the lease modified this provision. 895 S.W.2d at 836. This is the better-reasoned view.
While Texas recognizes that the lessee has an implied duty to market gas, Cabot Corp. v. Brown,
In construing language commonly used in oil and gas leases, we must keep in mind that there is a need for predictability and uniformity as to what the language used means. Parties entering into agreements expect that
Having concluded that marketing costs are to be shared by the royalty interest owners under a "market value at the well" clause, absent language to the contrary, it must be determined whether there is language in the leases in this case that re-allocates these costs.
The language of the pertinent clause states:
It is clear certain "deductions" are prohibited. The question that must be answered is from what are deductions prohibited. The clause says "from the value of Lessor's royalty." The value of Lessor's royalty is "market value at the well" for gas sold off the leased premises.
The court of appeals correctly observed that the intent of the parties is determined from what they actually expressed in the lease as written, not what they may have intended but failed to express. 895 S.W.2d at 836. However, the court of appeals did not apply this principle. It reasoned that the parties "must have intended something by this language," and in order to give the language some meaning, the court construed the proviso to mean that royalty owners do not share in post-production costs. Id.
There is little doubt that at least some of the parties to these agreements subjectively intended the phrase at issue to have meaning. However, the use of the words "deductions from the value of Lessor's royalty" is circular in light of this and other courts' interpretation of "market value at the well." The concept of "deductions" of marketing costs from the value of the gas is meaningless when gas is valued at the well. Value at the well is already net of reasonable marketing costs. The value of gas "at the well" represents its value in the marketplace at any given point of sale, less the reasonable cost to get the gas to that point of sale, including compression, transportation, and processing costs. Evidence of market value is often comparable sales, as the Court indicates, or value can be proven by the so-called net-back approach, which determines the prevailing market price at a given point and backs out the necessary, reasonable costs between that point and the wellhead. But, regardless of how value is proven in a court of law, logic and economics tell us that there are no marketing costs to "deduct" from value at the wellhead. See Piney Woods Country Life Sch., 726 F.2d at 231.
Further, prohibiting deductions "from the value of Lessor's royalty" is not the equivalent of directing that value be based on anything other than "market value at the well." The Court is not presented with a clause similar to one at issue in Judice v. Mewbourne Oil Co.,
As long as "market value at the well" is the benchmark for valuing the gas, a phrase prohibiting the deduction of post-production costs from that value does not change the meaning of the royalty clause. Thus, even if the Court were to hold that a lessee's duty to market gas includes the obligation to absorb all of the marketing costs, the proviso at
However, the proviso prohibiting the deduction of marketing costs would not be surplusage if we interpreted "market value at the well" to obligate the lessee to pay some, but not all, marketing costs. For example, it has been argued that at least some post-production costs, such as compression, should be borne solely by the lessee as part of its duty to market the gas, but that other costs, such as processing, should be shared by the lessor. See, e.g., Garman v. Conoco, Inc., 886 P.2d at 654. Such an interpretation of a royalty clause would mean that value is determined on a basis other than value "at the well." If "value" were not referable to "market value at the well," but encompassed other considerations, then the proviso could be construed to prohibit the deduction of any costs "required ... to market such gas." But such an approach injects uncertainty into the meaning of "market value at the well" leases, and could lead to a fact-finding inquiry in virtually every case as to what was and was not a cost "required to market the gas." This weighs heavily against adopting the approach apparently taken in Colorado where the lessee has a duty to "create a marketable product," and a fact question exists as to what costs are required to make the gas marketable. Id. at n. 3. Our Court has correctly concluded that "market value at the well" means just that, what a willing buyer would pay at the well, recognizing there would be costs to get the gas from the wellhead to a market.
There are any number of ways the parties could have provided that the lessee was to bear all costs of marketing the gas. If they had intended that the royalty owners would receive royalty based on the market value at the point of delivery or sale, they could have said so. If they had intended that in addition to the payment of market value at the well, the lessee would pay all post-production costs, they could have said so. They did not. There is no direct statement in the leases that the royalty owners are to receive anything in addition to the value of their royalty, which is based on value at the well. To the contrary, the leases only prohibit any deduction from value at the well. This distinction may be a fine one, but the language used is not ambiguous and must be given its ordinary meaning.
We cannot re-write the agreement for the parties. See, e.g., Exxon v. Middleton, 613 S.W.2d at 245 (quoting Vela, 429 S.W.2d at 871) (explaining that if Exxon had intended its royalty obligation to be based on the prices it actually received under long term sales contracts, it could have agreed in the lease that royalty would be based on the "amount realized" from the sale, rather than "market value at the well").
* * * * * *
For the foregoing reasons, I concur in the judgment of the Court.
Justice GONZALEZ, joined by Justice ABBOTT, dissenting.
The simple question presented in this case is whether Heritage can deduct transportation costs from the value of NationsBank's royalties under these leases. The language at issue, which is common to each contract, reads as follows:
What could be more clear? This provision expresses the parties' intent in plain English, and I am puzzled by the Court's decision to ignore the unequivocal intent of sophisticated parties who negotiated contractual terms at arm's length. See M/S Bremen v. Zapata Off-Shore Co.,
Fundamental principles of Texas law hold that competent parties enjoy the utmost freedom of contract and that courts will enforce a contract freely and voluntarily made for a lawful purpose. Crutchfield v. Associates Inv. Co.,
Heritage was free to bargain over whether NationsBank would have the right to participate in post-production business activities and receive royalties derived from those activities. The lease provision incorporates all four of the distinct business activities into which most gas production operations can be divided: production, gathering, marketing, and processing. It clearly excludes deductions for "any required processing, cost of dehydration, compression, transportation, or other matter to market such gas." The drafters of this clause could have allowed for deductions of the cost of any of the distinct business activities that occur after the production of gas, but chose not to include language to that effect. The language in the lease provision is clear, and in the absence of fraud or misrepresentation, a party is charged with knowing the legal effect of a contract voluntarily made. Barfield v. Howard M. Smith Co.,
The majority and the concurrence both state that they agree with the trial court and the court of appeals that the leases in question are unambiguous.
When a contract contains an ambiguity, we consider the words used in the instrument, in light of the surrounding circumstances, and apply the appropriate rules of construction to settle their meaning. Harris v. Rowe,
I have one final concern about today's decision. By attributing an unequivocal, precise meaning to "market value at the well" in oil and gas leases, the Court announces a new rule that should be applied only prospectively. See generally Carrollton-Farmers Branch Indep. Sch. Dist. v. Edgewood Indep. Sch. Dist.,
This decision wrongfully denies parties such as NationsBank the right to collect royalty payments for which they clearly bargained. For the foregoing reasons, I dissent.
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