Recent Texas Court Decisions on Recouping or Suspending Royalty Payments
By Christopher M. Hogan, Trial Attorney & Founding Partner, Hogan Thompson LLP
07/18/2023—A common fact of the oil patch in Texas (and beyond) is that royalty payment mistakes happen. Through prior period adjustments (“PPAs”) and other similar devices, operators often find themselves recouping royalties from an overpaid owner in order to make sure an underpaid owner is made whole. But royalty owners do not like having “their” money taken away and often threaten to (or actually proceed to) initiate litigation. What’s an operator to do?
Suspending royalty payments is one option. Rather than making a risky payment that it may need to later recoup, operators have the ability to suspend making disputed payments in certain circumstances under Texas statutes. But royalty owners often do not like being in suspense—that is “their” money you’re holding—and they again can threaten to (or actually proceed to) initiate litigation. What’s an operator to do?
Considering the frequency with which this issue arises, there is surprisingly little caselaw in Texas on an operator’s right to recoup or suspend royalties. Yet, in the last few months, several cases have come down touching on these exact issues.
Recoupment obligations may follow a transfer of ownership in a lease.
The first case on this analysis—DDR Weinert, LTD v. Ovintiv USA, Inc., No. SA-22-CV-00558-XR, 2023 WL 4054600 (W.D. Tex. June 16, 2023)—is particularly close to my heart as I represented Ovintiv in the case. In DDR Weinert, Ovintiv had inadvertently overpaid certain royalty owners (including Duane D. Richter and Colleen V. Richter (the “Richters”)) from 2016 to 2018. Id. at *1. In 2017, the Richters transferred their ownership interest in the leases at issue to the Plaintiffs in the case, which were entities over which the Richters retained control. Id. *1 & n.4. In 2018, Ovintiv noted the overpayment and conducted a PPA to recoup from the Plaintiffs the overpaid funds. The Plaintiffs sued Ovintiv, claiming that Ovintiv had wrongfully withheld proceeds owed to the Plaintiffs.
The trial court outlined how recoupment generally refers to “various non-judicial mechanisms by which oil operators (also referred to as “payors”) recover overpaid monies.” Id. at *4. It noted that “the parties agree that recoupment is a common and established practice in [the oil and gas] industries.” It also found that recoupment often takes place through two different methods. The first is “self-help” when “payors will notify royalty owners of the overpayment and communicate their intent to correct the mistake through future adjustments” without any kind of lawsuit. Id. The second is when an operator “forego[s] self-help recoupment and sue payees for reimbursement.” Id. The court recognized that the first kind of recoupment was at issue in the case.
After this thorough discussion of recoupment, the court turned to the facts before it. It noted that when the Richters transferred the leasehold interests at issue to plaintiffs, the relevant instruments at issue made the transfer “subject to” previous indebtedness. Id. “Phrased differently, the Richters' royalty and ownership interests were encumbered or indebted by this overpayment,” and this indebtedness went to plaintiffs through the transfer of the interests. Id. The court also noted that the plaintiffs had signed division orders under which they “explicitly agreed to ‘indemnify and reimburse’ Defendant for any funds received that they were not entitled to, including prior overpayments.” Id. at *6. The Court concluded that based on both the transfer instruments and the division order, “Plaintiffs contractually assumed the Richters' debt in the amount of Defendant's prior overpayment,” and Ovintiv was entitled to recoup those overpaid funds.
The DDR Weinert case provides operators with an excellent tool for recoupment. Not only does the opinion provide a legal foundation for the general act of recouping overpaid royalties, but it also should prevent potential maneuvers on the part of royalty owners that transfer interests to affiliates in order to avoid having overpayments recouped by operators.
A signed division order may not save the operator from a lawsuit.
While the signed division order in the DDR Weinert case worked to stop a claim against Ovintiv, it may not always protect an operator under Texas law. In Perdido Properties LLC on Behalf of Bremer v. Devon Energy Prod. Co., L.P., --- S.W.3d ---, 2023 WL 3511234 (Tex. App.—Eastland May 18, 2023, no pet. h.), the Court looked at a lawsuit against Devon by purported lessors in a complicated title dispute involving what the court referred to as the “Bray Interest.”
While numerous issues were raised in the lawsuit, the one of the most importance for operators was Devon’s defense based on Gavenda v. Strata Energy, Inc., 705 S.W.2d 690 (Tex. 1986). In Gavenda, the Texas Supreme Court outlined that in certain instances an underpaid royalty owner does not have recourse against an operator if there is a signed division order in place:
In the typical case, purchasers and operators following division orders pay out the correct total of proceeds owed, but err in the distribution, overpaying some royalty owners and underpaying others. If underpaid royalty owners' suits against purchasers and operators were not estopped, purchasers and operators would pay the amount of the overpayment twice—once to the overpaid royalty owner under the division order and again to the underpaid royalty owner through his suit. They would have double liability for the amount of the overpayment. Exposing purchasers and operators to double liability is unfair, because they have relied upon the division order’s representations and have not personally benefited from the errors.
Id. at 692. Rather than suing the operator, the underpaid royalty owner “can recover from the overpaid royalty owners” to get back their funds.
In Perdido Properties, Devon sought to use Gavenda to defend against the claims made against it. Devon noted that it had paid out of all of the monies owed to the Bray Interest based on signed division orders covering that interest and it did not retain any of the funds allegedly owed to the plaintiffs. The plaintiffs argued that Gavenda was inapplicable because the plaintiffs (and their predecessors) did not sign Devon’s division order.
Devon prevailed in the trial court, and the plaintiffs appealed. The appellate court noted that “Devon’s reliance on Gavenda is understandable because unlike [the operator in Gavenda], Devon was not unjustly enriched—it paid out the total amount of royalty due for the Bray Interest, albeit to the wrong parties.” Id. at *8. But the court recognized that Gavenda was not squarely on point because it did not involve “a non-signatory to division orders suing an operator that paid out royalties to the wrong royalty owner.” Id. The Court examined several other cases that discussed Gavenda and found that in general it stands for the proposition that “division orders are not binding to preclude a claim against the lessee when the lessee retains a benefit from the erroneous division orders and is therefore unjustly enriched.” Id. at *9.
But Devon was not using Gavenda for this purpose, but rather to argue that Gavenda should preclude all claims against an operator if it has fully paid out funds owed under division orders:
Devon relies on Gavenda for a different proposition—that if the lessee has paid out all out of the royalties due for a particular interest under division orders executed by other royalty owners, the unpaid royalty owner has no claim against the lessee because the lessee has not been unjustly enriched. Instead, Devon contends that the unpaid royalty owner’s sole remedy is to pursue a claim for unjust enrichment against the overpaid royalty owners.
Id. The court of appeals did not find Texas caselaw on point to this argument but did recognize that the North Dakota Supreme Court had rejected a similar argument in Acoma Oil Corp. v. Wilson. 471 N.W.2d 476 (N.D. 1991) and follow-on cases that cited Gavenda. Those decisions found that “It was of no consequence that the operator may have been exposed to double liability in this situation because it had not relied to its detriment on any actions taken by the non-signatory.” Perdido Properties, 2023 WL 3511234, at *10. The court of appeals found these cases “instructive and persuasive,” and thus ruled that “the holding in Gavenda does not preclude [Plaintiffs’] suit against Devon for unpaid royalties.” Id.
Perdido Properties shows that while division orders can be a powerful defensive tool against owners that have signed them, they will not necessarily protect an operator from claims brought by interest owners that are not signatories to those division order.
The Texas Supreme Court weighs in on when operators can withhold disputed payments.
What Devon might have done in Perdido Properties is withhold payments to all of the potential interest holders at issue. The Texas Natural Resources Code permits an operator to do this when there is “a dispute concerning title that would affect distribution of payments,” or a “reasonable doubt that the [royalty owner] . . . has clear title to the interest in the proceeds or production.” See Tex. Nat. Res. Code § 91.402(b). A recent Texas Supreme Court case examined when a producer can rely on this provision.
In Freeport-McMoRan Oil & Gas LLC v. 1776 Energy Partners, LLC, --- S.W.3d ---, 2023 WL 3556695 (Tex. May 19, 2023), the Court looked at a dispute stemming from an earlier lawsuit between 1776 Energy Partners and Longview Energy. Longview sued 1776 claiming that 1776 acquired properties in Karnes County that should have gone to Longview. A jury agreed and based on that verdict a judge ordered 1776 to transfer its interests in the leases at issue to Longview. While that case was pending, Ovintiv (an operator of wells in which 1776 had an interest) suspended payments to 1776. Eventually, the Texas Supreme Court overturned the trial court’s order against 1776. Immediately after this ruling, Ovintiv paid 1776 all of the funds it had been withholding.
For 1776, however, this was not enough. It sued Ovintiv to collect the interest that had accumulated during the time that Ovintiv was withholding its funds. Ovintiv prevailed on summary judgment in the trial court, but the San Antonio Court of Appeals reversed, claiming that fact questions existed that precluded summary judgment. The Texas Supreme Court took the case.
The Court first looked at whether Ovintiv had shown there was “a dispute concerning title that would affect distribution of payments.” Tex. Nat. Res. Code § 91.402(b). 1776 argued that the trial court judgment did not affect the distribution of payments because 1776 had appealed the trial court’s ruling and it never actually transferred ownership of the leases at issue. The Supreme Court, however, focused on the statute’s use of “would affect” and how that language focused on future possibilities rather than an operator’s obligations on the day it suspended payment:
The inclusion of “would” as an auxiliary verb with “affect” as a predicate verb alters the sentence’s meaning so that, instead of requiring a “current effect,” the provision requires only an expected future effect. In other words, because the sentence includes “would,” it does not require that the dispute currently alter or influence distributions at the time the payor withholds the distributions.
Id. at *4. Thus, Ovintiv was permitted to withhold payments because “the dispute concerning title was, at that time, at least expected or likely to influence or alter the distribution of the payments Ovintiv owed to 1776 Energy.” Id.
The Court also looked at whether Section 91.402’s other safe-harbor provision applied because Ovintiv had a “had a ‘reasonable doubt’ that 1776 Energy had ‘clear title to the interest in the proceeds of production.’” 1776 argued that reasonableness was a question for the jury, not a question of law, and was thus not appropriate for summary judgment. Again, the Court disagreed. “While questions of reasonableness must be submitted to a factfinder when a genuine disagreement about the facts prevents the law from generating an objective answer,” that caselaw did not require “that a factfinder must resolve all issues touching on reasonableness.” Id. at *5. “Rather, the legal standard for reasonableness remains objective even if the ‘controlling facts’ are in doubt.” Id. Thus, reasonableness may present a question of law ‘when from the facts in evidence but one rational inference can be drawn.’” The Court held that this rule applied to the dispute at hand. The Court found that “Longview’s claims and pending lawsuit . . . clouded 1776 Energy’s title to the production proceeds” and permitted Ovintiv to withhold proceeds. The Court went on to provide that “the very existence of the underlying dispute, so long as it was not frivolous” justified an operator’s withholding under the statute.
The Freeport-McMoRan Oil & Gas case is an important one for operators in Texas. Had 1776’s argument on reasonableness prevailed, operators could find themselves dragged into a jury trial every time they had a good-faith basis to withhold disputed proceeds. The very threat of having to proceed with such a case could be used by plaintiffs to strongarm operators into giving interest or other consideration when none is owed under Texas law. Such efforts will likely come up short now in light of this decision.
Christopher M. Hogan Trial Attorney & Founding Partner chogan@hoganthompson.com | 713.671.5642
Chris Hogan focuses his litigation practice on resolving complicated disputes for corporate and individual clients, particularly those in the energy industry. Chris has substantial first-chair experience in federal court, state court, and arbitration proceedings. is honored to represent as lead counsel major energy companies such as Apache, BPX, Chevron, ConocoPhillips, Devon, EOG, Marathon Oil, Mewbourne, and Ovintiv.