On September 15, 2014, the New Mexico Supreme Court entered a decision in First Baptist Church of Roswell v. Yates Petroleum Corp., a case that could call into question the validity of royalty agreements and division orders throughout New Mexico and that will have broad implications for how New Mexico operators draft and negotiate such agreements in the future. In rejecting a contractual provision that allowed an operator to withhold interest payments on monies held in suspense, the state supreme court articulated a strong state policy in favor of royalty interest holders, elevating that policy over private parties’ freedom to contract in oil and gas transactions.
The New Mexico Oil and Gas Proceeds Act ( “OGPA”), N.M. Stat. Ann. §§ 70-10-1 to -6, requires that royalty payments on oil and gas production be paid to royalty interest owners within six months after the first sale of oil and gas from the well. The Act also provides that, in instances where payments cannot be made within the six-month period because, among other reasons, there is a delay in determining who is legally entitled to receive the payments, the royalty payor shall place royalty proceeds in a suspense fund until the proper recipient of royalties is determined. Once the proper payee is determined, the Act directs that “[t]he person entitled to payment from the suspended funds shall be entitled to interest on the suspended funds from the date payment is due.”
The plaintiffs in Church of Roswell owned royalty interests in oil and gas production from a well that Yates Petroleum (“Yates”) drilled and operated in Eddy County, New Mexico. In August 2002, the well began producing and Yates therefore had proceeds to distribute to royalty interest owners. Yates sent form division orders to each of the plaintiffs; the form division order required each of the plaintiffs to satisfy certain title requirements before Yates would pay the individual owner the owner’s share of the proceeds from the well. In the event that a royalty owner was unable to establish marketable title, the division order expressly authorized Yates “to withhold payments of interest until the claim [over title] is settled.” Each of the plaintiffs executed the form division order. Consistent with the plain language of the form division order, Yates then withheld payment of interest on royalty payments to those plaintiffs that could not establish clear, marketable title within six months.
In Church of Roswell, the New Mexico Supreme Court rejected this explicit contractual exception to the interest payment requirement, holding that the OGPA “is unambiguous and supports a public policy that entitles payees to receive interest on the oil and gas royalties that are held in suspense for a period longer than six months.” The supreme court ruled expressly that the interest requirement represented a statutory provision that “cannot be contracted around.”
The supreme court’s opinion in Church of Roswell is particularly troubling because the scope of the court’s decision is not limited to the provision requiring interest payments on monies in suspense. Essential to an understanding of the decision is the supreme court’s conclusion that the language of the OGPA reflects “a strong public policy in favor of establishing the rights of royalty interest owners.” The supreme court explained that “every Section of the Act” imposes affirmative duties on royalty payors and reasoned that the structure of the OGPA and the protections that the OGPA affords royalty interest owners “evidences the [New Mexico] Legislature’s acknowledgment of royalty interest owners’ lack of bargaining power in oil and gas transactions.”
Where New Mexico operators may previously have customized certain contractual arrangements on specific projects to account for unique circumstances attendant to those projects, the state supreme court has now held, at least with respect to the payment of royalties, that flexibility may no longer exist. A public policy that aims to “equalize the bargaining power between the parties in oil and gas transactions” now circumscribes oil and gas companies’ freedom to contract in New Mexico. Operators in New Mexico would be well served to review their existing royalty agreements for inconsistencies with the express terms of the OGPA and will need to ensure that agreements executed in the future are consistent with the Act.