Articles Posted in Oil and Gas Law

As readers of this blog know, we have been following the case of Marcia Fuller French, et al. v. Occidental Permian Ltd., which is an important Texas case involving gas royalties. You can read our previous blog post here. The case was heard by the Supreme Court of Texas on February 5, 2014 and the The Texas Supreme Court has issued its decision.

As you may recall, Martha Fuller French and the other Plaintiffs were royalty owners and lessors on two oil and gas leases in Scurry County and Kent County, Texas. One lease is referred to in the decision as the “Fuller Lease”, which was executed in 1948, and the other lease is referred to as the “Cogdell Lease”, which was leased 1949.

In 2001, Occidental Permian began injecting wells on these leases with carbon dioxide to boost oil production. As a result, the natural gas produced from these leases contained about 85% carbon dioxide. Occidental then treated the gas to remove the carbon dioxide and sold the remaining gas, sending the carbon dioxide back to be reused at the well. Occidental paid Ms. French and the others royalties on the gas after it was treated and then deducted treatment costs from the royalties.

An interesting case was in the news recently and oil and gas attorneys have been following it with interest. The case is Lisa Parr, et al. vs. Aruba Petroleum, Inc., et al.; County Court at Law No. 5, Dallas County, Texas; Cause Number: CC-11-01650.

The Background

The Parrs have a 40 acre ranch in Decatur, Texas which is about 60 miles northwest of Dallas, Texas. The ranch sits on the Barnett Shale. Robert and Lisa Parr and their 11 year old daughter Emma alleged that they started having health problems in 2008, including migraine headaches, dizziness and nausea. By 2009, Lisa Parr said: “(m)y central nervous system was messed up. I couldn’t hear, and my vision was messed up. My entire body would shake inside. I was vomiting white foam in the mornings.” She claimed that her husband and daughter had nosebleeds, vision problems, nausea, rashes and blood pressure issues.

As a Texas oil and gas attorney, I often explain to clients how important it is to be smart and review oil and gas leases, contracts and other legal documents before signing anything. So many people sign documents without reading or understanding them first and come to me after the fact, when it is much harder and often impossible to do anything about it–money and peace of mind have already been lost. I recently read a case, Ayala and Chesapeake Exploration LLC v. Soto, that exemplifies exactly this situation.

Natividad Soto is a 75 year old man and land and mineral owner in LaSalle County, Texas. He cannot read or write in English. He was approached by Henry Gilbert Ayala, a prison guard and mayor pro tem of Cotulla, Texas who was an acquaintance of Soto’s niece. Mr. Ayala allegedly pressured Mr. Soto into signing what Mr. Soto thought was an oil and gas lease. Mr. Soto actually signed a durable power of attorney to Ayala, giving Ayala authority to sign oil and gas leases and certain other documents for Mr. Soto.. Mr. Soto claims no one explained what the document was and he did not seek assistance from anyone before he signed. Mr. Ayala filed the power of attorney in the county deed records and then signed two mineral leases with Chesapeake Exploration.

A few days later, Mr. Soto consulted an attorney. The attorney prepared and filed revocations of the power of attorney with the county clerk’s office. A few weeks later, Chesapeake sent a check of almost $239,000 as lease bonus to Ayala. Ayala kept the money and claimed that Soto agreed that Ayala could keep the bonus funds as his fee.

The Supreme Court of Texas will be considering an interesting case about oil and gas royalties for a Texas mineral owner. The case is Charles G. Hooks III et al. v. Samson Lone Star L.P.

The case arises from a dispute over oil and gas leases in Jefferson County and Hardin County, Texas. The mineral and land owner is Charles G. Hooks, III, who is also an oil and gas attorney. The Jefferson County lease provided that the lessee, Samson Lone Star LLC pay compensation to Mr. Hooks if drilling occurred within 1,320 feet of his property line. Samson drilled a directional well that bottomed out within that distance, but Samson never compensated Mr. Hooks as the lease required. With the two Hardin County leases, Mr. Hooks gave Samson permission to pool his mineral interests, but Mr. Hooks contended that Samson did not pay him for all production within the pool. Mr. Hooks also claimed that Samson was required to pay both royalties on the sale of oil and gas and on the same oil and gas as it existed in the reservoir, so called “formation production”.

In the trial court, Mr. Hooks was awarded more than $21 million on these claims. The case was appealed to the Houston Court of Appeals, which reversed the judgment of the trial court in a majority decision written by Justice Evelyn V. Keyes in 2012. The Houston Court of Appeals determined that, as to the Jefferson County lease, Mr. Hooks’ claim was barred by the statute of limitations and was based on an incorrect interpretation of his oil and gas lease. The Court noted that surveys on file for this well at the Texas Railroad Commission in 2000 and publicly accessible put Hooks on notice of the location of the bottom of Samson’s directional well, and as an oil and gas lawyer, Hooks should have been aware of his claim if he reviewed both those surveys. Unfortunately, Hooks did not file the lawsuit against Samson until after the four year statute of limitations that applied to his claim had expired.

A recent case decided by the U.S. Sixth Circuit Court of Appeals holds a cautionary tale for Texas investors or any one who may want to invest in oil and gas. The case is United States v. Smith decided on April 15, 2014.

This case involved the Smith brothers, Michael and Christopher, who operated a company called Target Oil. Target conducted speculative oil drilling in several states, including Texas, but also in Kentucky, West Virginia, and Tennessee. The Smiths told potential investors that certain wells were sure-fire investments, but these wells often produced no oil at all. In fact, some of the wells had not even been drilled. Investigators discovered that from 2003 to 2008, Target Oil received approximately $15.8 million from investors, but only distributed royalties amounting to $460,000. Their operation was a classic Ponzi scheme. That means that the Smith brothers paid new investors from the investment funds of previous investors, rather than from the production proceeds from the wells they were supposed to be drilling. As in all Ponzis, for the first few months the investor thinks they’ve made a good investment. At some point, as in all Ponzis, the fraudsters run out of new investors to scam and the returns to investors stop. The newer investors get nothing at all. These kinds of schemes seem to come out of the woodwork when the price of oil approaches $100 per barrel.

Michael and Christopher Smith were arrested and charged with conspiring with others to defraud investors of millions of dollars. In the trial court, Michael Smith was convicted of conspiracy to commit mail fraud and of 11 substantive counts of mail fraud. He was sentenced to 120 months in prison and ordered to pay $5,506,917 in restitution. Christopher Smith was convicted by the same jury on seven counts of mail fraud. He was sentenced to 60 months in prison and ordered to pay $1,652,075 in restitution. The Sixth Circuit Court of Appeals affirmed the convictions in an opinion written by Justice Ronald Lee Gilman. The Court rejected the Smith brothers’ complaints of insufficient evidence, that the government introduced evidence that effectively amended the indictment, that a defense witness was erroneously excluded, that their sentences were procedurally and substantively unreasonable and that their forfeiture judgment was excessive.

Not all Texas folks consult an attorney to prepare a will or to review an oil and gas lease or a pipeline easement they have been offered. Maybe they think lawyers are expensive and only for the wealthy or maybe they don’t want to take the time. Fortunately, there are affordable attorneys for virtually all situations, including those who review oil and gas leases. In fact, there are instances where it is critically important to consult a lawyer, and the legal fee for a specific service is often a fraction of what people end up losing by signing boilerplate legal documents without understanding the the documents or the implications those documents may have for their family’s future.

A recent case from Florida highlighted this problem. The case is James Michael Aldrich vs. Laurie Basile et al from the Supreme Court of Florida. The case involved the will of Ann Aldrich. In 2004, she made a will using an “E-Z Legal Form”. The will left her property to her sister, and if her sister died before Ann did, then to her brother. Ms. Aldrich’s sister died first, so her brother was the sole heir to her estate according to the will. However, this “E-Z Legal Form” didn’t have a residuary clause. Ms. Aldrich also left a written note after her sister died leaving her possessions to her brother, except for certain bank accounts that were to be left to this brother’s daughter. But the document only had one witness, which made it invalid as a will under Florida law.

When Ms. Aldrich died, two nieces sued to receive part of the estate. These nieces were the daughters of a different brother of Ms. Aldrich, who had also already died before Ms. Aldrich. Even though these two nieces are not mentioned anywhere in the will, the Florida Supreme Court decided in their favor in a decision written by Justice Peggy Quince. Since the “E-Z Legal Form” did not have a residuary clause, Ms. Aldrich only intended for the property specifically mentioned in the will to be distributed. The Court found that all other assets, such as money acquired after the will was signed in 2004, had to be distributed under the laws of intestacy, which is the law that covers the distribution of property of someone who does not have a will.

A recent case that was decided by the Texas Court of Appeals in San Antonio illustrates the problems when mineral owners sign a “standard” form for their oil and gas lease and why they should consider getting the opinion of an experienced Texas oil and gas attorney before they sign. Failing to do so could end up costing you money every month.

The decision is Chesapeake Exploration, LLC v. Hyder. The Court, in a unanimous decision written by Justice Sandee Bryan Marion, ruled that, despite the claims of the well operator, post-production costs could not be deducted from the mineral owner’s royalties, based on the specific language of the lease before the Court. This particular lease was most definitely not a standard form and appeared to have been carefully drafted by the Hyder’s attorney.

The Hyder lease was executed on September 1, 2004 with another oil company, and then the lease was assigned to Chesapeake Exploration LLC. The leased premises consisted of two tracts of 1,037 acres and 948 mineral acres in Johnson County and Tarrant County. The lease allowed Chesapeake to drill from existing well sites adjacent to the leased premises, as well as within the leased premises itself. For the wells on the leased premises, the Hyders were paid a precentage royalty. For wells outside the leased premises, the Hyders were to be paid a specified percentage as overriding royalties.

In October 2013, the American Petroleum Institute and the American Fuel & Petrochemical Manufacturers (AFPM) submitted information to the Environmental Protection Agency (EPA) asking the EPA to lower the 2013 cellulosic biofuel quota because oil refiners would be forced to buy millions of dollars in unnecessary “credits” for cellulosic biofuel because the actual biofuel was unavailable.

In a very helpful (and surprising) turn, on January 23, 2014, the EPA announced that it would reconsider the 2013 quote due to this new information. The EPA determined the information was relevant and met statutory requirement for granting a reconsideration.

The government has hoped that cellulosic biofuel would replace ethanol, which has caused complaints over driving up prices of corn and the damage to engines. However, costs in producing cellulosic biofuels have delayed production, and so production hasn’t kept pace with government quotas. AFPM President Charles Drevna pointed out that the 2013 quota for cellulosic biofuels was six million gallons, which is absurd when only one million gallons were produced. Since they obviously cannot buy biofuel that doesn’t exist, EPA requires oil refiners to buy “credits” instead. API estimated that buying these credits would cost oil refiners $2.2 million in 2013. Mr. Drevna explained that in March 2013 the EPA set the 2012 quota at zero. In reality, these credits are a penalty for not complying with a law that is impossible to comply with!

A decision from the United States Tax Court in December 2013 has interesting implications for Texas oil and gas leases and Texas mineral owners. In Dudek v. Commissioner, the Tax Court examined the characterization of lease bonus and whether bonus is eligible for depletion allowance.

The Dudek decision dealt with three main issues: 1) whether the bonus payment received by the taxpayer pursuant to an oil and gas lease is taxable as ordinary income or as a capital gain; 2) whether the taxpayer is entitled to a depletion deduction; and 3) whether the taxpayer is liable for an accuracy-related penalty under section 6662(a) for a substantial understatement of income tax.

Michael Dudek, the taxpayer and the petitioner in this case, is a certified public accountant and an attorney licensed to practice law in Pennsylvania. In 1996 and 1998, Dudek and his wife, Brenda, bought a total of 353 acres of land. The Dudeks leased the oil and gas rights to EOG Resources Inc., receiving a 16% royalty and a bonus of over $883,000. As many of you know, bonus is consideration for the primary term of the lease and is not contingent on any extraction or production of oil or gas. The Dudeks reported the lease bonus as a long term capital gain on their income tax return.

The Texas Supreme Court will hear a new case involving royalties on natural gas. Those involved with oil and gas law in Texas will be paying attention, as the case will probably be important. The case is is Occidental Permian Ltd. v. Marcia Fuller French et al, and it is one of the first cases to deal with allocation of the cost of removing carbon dioxide from produced gas following tertiary recovery of that gas with CO2. The appeal was heard by the Eastland Court of Appeals of Texas in October 2012.

The Facts

The Plaintiffs in the trial court, Ms. French and others, were the lessors on two different oil and gas leases in Scurry County and Kent County, Texas. Occidental Permian began injecting wells on these leases with carbon dioxide (CO2) in 2001 in order to boost oil production. As a result, the well produced natural gas that was about 85% CO2. Occidental had the gas treated off site to remove the carbon dioxide and sold the resulting gas. The extracted CO2 was sent back to the well to be reinjected. Occidental paid royalties on the gas after it was treated, and also deducted the treatment costs from the Plaintiffs’ royalties.