With production in the Barnett Shale in full swing, it is no surprise that mineral owners have filed a number of lawsuits against operators challenging the amount of their royalty payments. And although lawsuits across the state name a variety of operators as defendants, one operator, Chesapeake, is a common defendant in suits filed in Tarrant and neighboring counties, perhaps because Chesapeake controls what may be the largest amount of acreage in the area. The cities of Arlington and Fort Worth, Dallas-Fort Worth Airport, school districts in Arlington and Fort Worth, developer Ed Bass, and a number of individual mineral owners have all brought suit challenging Chesapeake’s royalty calculations and payments.
One common claim among nearly all of the lawsuits is that the operator short-changed the mineral owner by improperly deducting some form of cost before calculating royalties. The results of such claims can go either way, depending on the facts. For example, a Texas Supreme Court opinion issued at the end of June affirmed that Occidental Permian could deduct costs of stripping CO2 from casinghead gas. On the other hand, a recent Court of Appeals decision affirmed a Tarrant County judgment against Chesapeake awarding the royalty owners approximately $700,000 for deducting improper costs, plus attorneys’ fees and interest—all of which ultimately totaled nearly $1 million dollars. Chesapeake is seeking review of the decision by the Texas Supreme Court. (The two opinions can be found on the internet by searching “French and Occidental Permian Supreme Court” and “Chesapeake Exploration v. Hyder.”)
Another type of underpayment claim against operators can arise when the “sales price” of the gas is measured by a “sweetheart” sale to an affiliate instead of a third party, which then reduces the amount of royalty due. It is not uncommon for operators to sell minerals to affiliated companies and state laws differ on whether and under what circumstances the practice is permissible. No Texas court has yet found liability as a result, but at least one has warned that the practice is “inherently suspect.” Warnings like that can provide all the fodder needed for an operator to face expensive litigation.
More underpayment litigation can arise from royalty owners asserting that operators owe royalties on “lost or unaccounted for gas” (gas lost between the wellhead and point of sale or flared), sales at below-market prices, incorrect calculations, and a number of other items. Every challenge will be a fact-intensive inquiry that will depend on a multitude of interrelated factors and legal interpretation of the precise language of each lease. From all these challenges, however, the lesson for mineral owners and for operators alike is to be certain that there is careful compliance with all calculation provisions in the documents at issue.