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Important Gas Royalty Case for Texas Mineral Owners

Recently the Fifth U.S. Court of Appeals issued an interesting decision in the case of Warren et al. v. Chesapeake. This very important case for Texas mineral owners is based on a lawsuit against Chesapeake Exploration for what the Plaintiffs claimed was the wrongful deduction of post-production costs from the Plaintiffs’ gas royalty payments.

The Facts

The Warren case involves three oil and gas leases in Texas. Charles and Robert Warren entered into leases with FSOC Gas Co. Ltd. Those leases were then assigned to Chesapeake, who used an affiliate, Chesapeake Operating, to drill and operate the wells. Chesapeake deducted post-production costs from the royalty payments to the Warrens as well as from royalties to Abdul and Joan Javeed who joined the case as plaintiffs later. Chesapeake claimed that the leases authorized the deductions. The Plaintiffs asserted that Chesapeake breached the leases because the deductions did not comply with the lease provisions on calculating royalties. The complaint also included class action allegations on behalf of other royalty owners with similar leases with Chesapeake Exploration.

The U.S. District Court Proceedings

The Plaintiff based their claim in part on the previous decisions of the Texas Supreme Court in Heritage Resources, Inc. v. NationsBank and Judice v. Mewbourne Oil Co.. The District Court dismissed the claims of all four Plaintiffs with prejudice. That court held that since the leases contained “at the well” royalty provisions, Chesapeake was authorized to make post-production deductions in determining the income on which royalties would be based despite the provisions in the Warren leases that the royalty would be free of certain post-production costs.

The Fifth Circuit Decision

The Plaintiffs appealed their case to the Fifth Circuit Court of Appeals. The Warrens claimed that their leases contained two sets of obligations owed by Chesapeake. The first involved the costs of exploration, production and marketing of gas, including the costs of compression, dehydration, treatment, and transportation. The second are shared obligations such as costs incurred subsequent to production. The Warrens claimed the deducted expenses fell under the first set of obligations and so were the obligation of Chesapeake alone. The Fifth Court of Appeals did not agree with this argument and upheld the District Court’s dismissal with prejudice on this issue. The Fifth Circuit held that the language of the lease expressly provides that the lessor will bear a proportionate part of the expenses of delivering marketable gas to a sales point other than the mouth of the well.

The next issue the Court addressed concerned the leases of both the Warrens and the Javeeds. The Javeeds lease contained differently worded royalty provisions than the Warren leases, but the appellate briefs to the Court focused on the Warrens’ leases, not addressing the differing provisions. The District Court had treated the Javeeds leases as “functionally equivalent” to the Warrens. For the first time in the reply brief before the Fifth Circuit the Plaintiffs addressed the differences, but these arguments were waived because they were asserted too late. The Fifth Circuit determined that the Javeeds claim should be dismissed without prejudice anyway because it was apparent from the face of the complaint and its attachments that they could not conceivably state a cause of action.

This case illustrates that language in oil and gas leases concerning the calculation of royalty can be technical and complicated. It is essential for a mineral owner to fully understand the terms of an oil and gas lease and what may or may not be deducted from royalties before it is signed. Take the time to consult an attorney before signing. It will save money and stress later.

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