IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 13-10601

GORDON POTTS; BRANDY WEST,

Plaintiffs–Appellants,

v.

CHESAPEAKE EXPLORATION, L.L.C.,

Defendant–Appellee.

Appeal from the United States District Court

for the Northern District of Texas 

Before JONES, SMITH, and OWEN, Circuit Judges.

PRISCILLA R. OWEN, Circuit Judge:

The meaning of royalty provisions in an oil and gas lease are in dispute.

Gordon Potts and Brandy West (the lessors) appeal the district court’s grant of 

summary judgment in favor of the lessee, Chesapeake Exploration, L.L.C. 

(Chesapeake). We affirm. 

I

Potts and West are two of the lessors in an oil, gas, and mineral lease in

which Chesapeake is the successor-lessee to FSOC Gas Co., Ltd. (FSOC). 

Three paragraphs of the lease are at issue. Paragraph 11 provides in relevant 

part:

The royalties to be paid by Lessee are: . . . on gas . . . the market 

value at the point of sale of 1/4 of the gas sold or used. . . . 

Notwithstanding anything to the contrary herein contained, all 

United States Court of Appeals

Fifth Circuit

FILED

July 29, 2014

Lyle W. Cayce

Clerk

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royalty paid to Lessor shall be free of all costs and expenses related 

to the exploration, production and marketing of oil and gas 

production from the lease including, but not limited to, costs of 

compression, dehydration, treatment and transportation.

Paragraph 29 contains a “favored nation” provision, which states:

Lessee agrees if Lessee or any of its Working Interest Partners has 

agreed to pay or later agrees to pay a higher royalty or bonus 

consideration to another landowner, mineral owner or other 

parties, (in the same drilling unit, spacing unit or pooled or utilized 

land to which the leased lands are included), then Lessee shall pay 

to Lessor an amount based on such higher royalty, or bonus 

consideration retroactive to the effective date of the Lease(s).

Paragraph 37 provides, in pertinent part:

Payments of royalties to Lessor shall be made monthly and shall 

be based on sales of leased substances to unrelated third parties at 

prices arrived at through arms length negotiations. Royalties to 

Lessor or leased substances not sold in an arms length transaction 

shall be determined based on prevailing values at the time in the 

area. Lessee shall have the obligation to disclose to Lessor any 

information pertinent to this determination. 

An affiliate of Chesapeake, Chesapeake Operating, Inc. (COI), operates 

the lease on Chesapeake’s behalf. COI, as agent for Chesapeake, sells gas 

produced from the lease to Chesapeake Energy Marketing, Inc. (CEMI), 

another affiliate of Chesapeake, at the wellhead located on the lessors’ 

property. CEMI then transports the gas through a gathering system and

resells it to unaffiliated purchasers at gas pipeline hubs that are considerable 

distances from the wellhead. The sales to unaffiliated purchasers occur at 

delivery points that include the Houston Ship Channel and locations in 

Louisiana and Alabama. CEMI pays Chesapeake the weighted average sales 

price that CEMI receives when it sells the gas downstream, after deducting

post-production costs that CEMI incurs between the wellhead and the points 

at which deliveries to unaffiliated purchasers occur. The royalty that 

Chesapeake pays to the lessors is 1/4 of the price it receives from CEMI.

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Potts protested to Chesapeake that his royalty payments were

improperly calculated because post-production costs had been deducted in 

arriving at the value on which royalty was based. Potts also questioned 

whether Chesapeake had complied with the favored nation clause and 

demanded access to Chesapeake’s records. Chesapeake initially agreed that it 

should not have deducted post-production costs in calculating royalties and 

paid Potts accordingly. However, Chesapeake subsequently changed its 

position, asserting that its original concession regarding post-production costs 

was a mistake. Chesapeake conceded that it had failed to pay Potts the amount 

he was due under the favored nation provision, but in tendering what was owed 

under that provision of the lease, Chesapeake withheld the amount it

contended was an “over-payment” of royalties due to post-production costs that 

Chesapeake had not, but was entitled to, deduct.

Potts filed suit against Chesapeake in Texas state court, alleging breach 

of contract and seeking a declaratory judgment that Chesapeake was not 

permitted to deduct post-production costs in calculating royalty. After 

Chesapeake removed the case to federal district court on the basis of diversity 

jurisdiction, West joined the litigation as a plaintiff. West claimed that 

Chesapeake initially paid her royalties without deductions for post-production 

costs, but then ceased remitting payments altogether on the ground that she 

had been overpaid and Chesapeake was recouping the difference out of future 

payments. 

The parties filed cross-motions for summary judgment. The district 

court granted Chesapeake’s motion and denied that of the lessors. Construing 

the lease under Texas law, the court held that Chesapeake was permitted to 

calculate “market value at the point of sale” by starting with the market value

received from unaffiliated purchases and subtracting reasonable post3

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production costs incurred between the downstream points of sale to 

unaffiliated purchasers and the point of sale to CEMI.

The lessors moved for reconsideration, arguing inter alia that because 

royalty payments are to be calculated based on sales to unrelated third parties 

under paragraph 37 of the lease, the “point of sale” to be considered is the point 

at which CEMI sold the gas to unaffiliated purchasers. The district court 

denied the motion. The lessors timely appealed.

II

“We review a district court’s grant of summary judgment de novo, 

applying the same standard as the district court.”1 Under that standard, 

“[s]ummary judgment is proper ‘if the movant shows that there is no genuine 

dispute as to any material fact and the movant is entitled to judgment as a 

matter of law.’”2 “We generally review a decision on a motion to alter or amend 

judgment under [Federal Rule of Civil Procedure] 59(e) for abuse of discretion. 

To the extent that a ruling was a reconsideration of a question of law, however, 

the standard of review is de novo.”3

III

The parties agree that Texas law applies in construing the lease.4 Under 

Texas law, “[a]n oil and gas lease is a contract, and its terms are interpreted 

as such.”5 The parties further agree that the lease in this case is unambiguous. 

“In construing an unambiguous oil and gas lease our task is to ascertain the 

1 10 Ring Precision, Inc. v. Jones, 722 F.3d 711, 717 (5th Cir. 2013) (citation omitted).

2 Id. (quoting FED. R. CIV. P. 56(a)).

3 Miller v. BAC Home Loans Servicing, L.P., 726 F.3d 717, 721-22 (5th Cir. 2013) 

(citations and internal quotation marks omitted).

4 See Clardy Mfg. Co. v. Marine Midland Bus. Loans Inc., 88 F.3d 347, 352 (5th Cir. 

1996) (“We look to state law to provide the rules of contract interpretation.”).

5 Tittizer v. Union Gas Corp., 171 S.W.3d 857, 860 (Tex. 2005) (per curiam).

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parties’ intentions as expressed in the lease.”6 We are to “examine the entire 

document and consider each part with every other part so that the effect and 

meaning of one part on any other part may be determined.”7 Additionally, 

“[w]e give terms their plain, ordinary, and generally accepted meaning unless 

the instrument shows that the parties used them in a technical or different 

sense.”8

A

We begin our analysis of the lease’s provisions with the royalty clause in 

paragraph 11. It provides that royalties on gas are “the market value at the 

point of sale of 1/4 of the gas sold or used.” This unambiguously requires 

Chesapeake to pay 1/4 of the market value of the gas at the point at which 

Chesapeake sells the gas. If, as in the present case, the lessee sells the gas at 

the wellhead, there generally will be no post-production costs incurred by the

lessee. If the lessee sells the gas downstream from the wellhead, then the 

lessee would be required to pay 1/4 of the market value of the gas calculated at 

that point of sale and could not deduct post-production costs incurred between 

the wellhead and the point of sale.

The lessors contend that there are other provisions in the lease that 

modify or override this part of the royalty clause. They rely on the following 

language, also found in the royalty clause in paragraph 11 of the lease:

Notwithstanding anything to the contrary herein contained, all 

royalty paid to Lessor shall be free of all costs and expenses related 

to the exploration, production and marketing of oil and gas 

production from the lease including, but not limited to, costs of 

compression, dehydration, treatment and transportation.

6 Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121 (Tex. 1996).

7 Id.

8 Id.

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The above-quoted language directs that “royalty” is to be “free of all costs 

and expenses related to the exploration, production and marketing of” gas 

“including, but not limited to, costs of compression, dehydration, treatment and 

transportation.” As discussed above, when gas is sold at the wellhead, there 

are typically no costs of compression, dehydration, treatment or 

transportation. When there are no such costs at the wellhead, the market 

value at the wellhead is “free of all costs and expenses,” as contemplated by 

the above-quoted paragraph, and there is nothing in the royalty clause 

“contrary” to the “[n]otwithstanding” sentence. If the gas is sold by the lessee 

downstream of the wellhead, then both the sentence providing for a 1/4 royalty 

and the “[n]otwithstanding” sentence contemplate that costs incurred by the 

lessee between the point of production and the point of sale are to be borne by 

the lessee. Since it is undisputed that gas sales by Chesapeake have occurred 

at the wellhead, and since the lessors do not contend that the sales to 

unaffiliated purchasers were at less than market value, Chesapeake could 

arrive at the market value at the wellhead by deducting reasonable postproduction costs to deliver the gas from the wellhead to the point at which the 

gas was sold to unaffiliated purchasers.

The district court correctly concluded that Chesapeake’s calculation of 

royalties is consistent with the methodology for calculating market value at 

the wellhead explained by the Supreme Court of Texas in Heritage Resources, 

Inc. v. NationsBank.9 In Heritage, the royalties to be paid under the leases

were a percentage of the gas’s “market value at the well.”10 The leases further 

provided that “there shall be no deductions from the value of [the] Lessor’s 

royalty by reason of any required processing, cost of dehydration, compression, 

9 939 S.W.2d 118 (Tex. 1996).

10 Heritage, 939 S.W.2d at 120-21.

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transportation, or other matter to market such gas.”11 The Supreme Court of

Texas held that the lessee had not breached the lease in arriving at market 

value of gas at the wellhead by deducting post-production transportation costs

from the market value ascertainable at a downstream point.12 The court 

explained, “[t]here are two methods to determine market value at the well.”13 

“The most desirable method is to use comparable sales” at the well.14 When 

information about such sales is not readily available, the market value at the 

well is determined by taking the market value of the gas at a point downstream 

where sufficient information is available, and then “subtracting reasonable 

post-production marketing costs,” such as transportation and processing 

expenses.15 The “no deductions” clause, the court continued, simply “restate[d]

existing law” by providing that the lessors’ royalty, which could be calculated 

using the two methods described, may not be further reduced because of 

costs.16

The lessors insist that that the “[n]otwithstanding” sentence is 

distinguishable from the “no deductions” clauses at issue in Heritage and 

should be given a different meaning. The clauses in Heritage stated that “there 

shall be no deductions from the value of [the] Lessor’s royalty by reason of any 

required processing, cost of dehydration, compression, transportation, or other 

matter to market such gas.”17

11 Id.

12 Id. at 123-24.

13 Id. at 122.

14 Id.

15 Id.

16 Id.

17 Id. at 120-21.

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The lessors contend that, unlike the clauses at issue in Heritage, a

sentence in their lease provides that all royalties shall be free of all costs. The 

lessors argue that the lease does not simply prohibit deductions from a given 

value, but provides affirmatively that the royalty may not be “burdened” with 

any costs. They maintain that subtracting post-production costs from sales 

that occur miles from the wellhead to derive the market value at the point of 

sale, in this case the wellhead, burdens the royalty with such costs.

This argument misunderstands Heritage and is mathematically 

unsound. The Heritage court held that the “no deductions” clauses were not 

in conflict with the royalty provisions. The deduction of post-production costs 

incurred between the wellhead and a downstream point at which market value 

could be ascertained was nothing more than a method of determining market 

value at the well in the absence of comparable sales data at or near the 

wellhead. The value of the gas, and therefore the value of the royalty, was not 

reduced. As the concurring opinion stated, “[t]he concept of ‘deductions’ of 

marketing costs from the value of the gas is meaningless when gas is valued 

at the well. Value at the well is already net of reasonable marketing costs.”18 

That reasoning is equally applicable to the clause at issue in this case. 

The value of the lessors’ royalty is a percentage of the market value at the point 

of sale, which in this case is at the well. A “net-back” method of calculation 

does not “burden” or reduce the value of the royalty.19

B

The lessors contend, however, that the lease prohibits the point of sale 

from being at the wellhead if Chesapeake sells the gas to an affiliated entity. 

18 Id. at 130 (Owen, J., concurring).

19 See also Warren v. Chesapeake Exploration, L.L.C., No.13-10619, 2014 WL 3511880, 

at *3 (5th Cir. 2014).

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The lessors rely on paragraph 37 of the lease, which requires that royalty 

payments be “based on sales . . . to unrelated third parties at prices arrived at 

through arms length negotiations.” 

Chesapeake argues that the lessors waived their reliance on paragraph 

37 by failing to raise the issue in the district court until the lessors’ motion for 

reconsideration. Even if the lessors preserved their reliance on paragraph 37,

a question that we do not reach, it does not support their position. Paragraph 

37 says, in pertinent part:

Payments of royalties to Lessor shall be made monthly and shall 

be based on sales of leased substances to unrelated third parties at 

prices arrived at through arms length negotiations. Royalties to 

Lessor or leased substances not sold in an arms length transaction 

shall be determined based on prevailing values at the time in the 

area. Lessee shall have the obligation to disclose to Lessor any 

information pertinent to this determination.

This section of the lease specifically contemplates that if the lessee sells 

the gas to an affiliate, the royalty shall “be determined based on prevailing 

values at the time in the area.” Paragraph 37 does not require the point of sale 

to be the point at which the gas is ultimately sold to a non-affiliated entity.

The lessors argue that construing “point of sale” as the point where 

Chesapeake sells the gas to CEMI would frustrate the parties’ expectations 

and their reliance on the concurring opinion in Heritage. They rely on the 

following passage from the concurring opinion:

There are any number of ways the parties could have provided that

the lessee was to bear all costs of marketing the gas. If they had 

intended that the royalty owners would receive royalty based on 

the market value at the point of delivery or sale, they could have 

said so.20

20 Heritage, 939 S.W.2d at 131 (Owen, J., concurring) (emphasis in original).

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The concurring opinion emphasized that the parties to a lease “may allocate 

costs . . . as they choose” and that courts must examine the specific language 

chosen in order to “determine how . . . costs were allocated under [the] 

particular leases” at issue.21 In this case, the language of the lease, including

paragraph 37, make clear that the royalty due the lessors is a percentage of 

the market value of the gas at the point at which the lessee sells the gas. As 

discussed above, had Chesapeake sold the gas at a point downstream from the 

wellhead, then the royalty would be 1/4 of the market value of the gas at that 

point. Post-production cost incurred between the wellhead and the point of 

sale could not be deducted in arriving at the market value at the point of sale 

under either the “1/4” royalty sentence in the royalty clause of paragraph 11, 

or any other provision in the lease. But Chesapeake has sold the gas at the 

wellhead. That is the point of sale at which market value must be calculated 

under the terms of the lessors’ lease.

C

The lessors contend that the district court erred by relying on Heritage,

asserting that the case has limited precedential value. They note that after 

the opinion in Heritage issued, one of the Justices who had joined the majority 

opinion recused himself. The other members of the Supreme Court of Texas

split 4-4 in ruling on a motion for rehearing. An opinion dissenting from the 

denial of rehearing reflects that two of the Justices who had originally joined 

the majority opinion had changed position and had expressed their agreement 

with the original dissenting opinion.22 The lessors argue that the Texas court 

21 Id. at 124.

22 See Heritage Res., Inc. v. NationsBank, 960 S.W.2d 619, 619 (Tex. 1997).

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was thus without a majority that agreed on the reasons supporting the 

judgment in Heritage.

Because rehearing was denied, the court’s opinion in Heritage was not 

withdrawn. The Texas court’s decision in Heritage remains binding law, as the

numerous cases from both the Supreme Court of Texas and this court citing 

that decision demonstrate.23 

* * *

For the foregoing reasons, the judgment of the district court is 

AFFIRMED.

23 See, e.g., Ramming v. Natural Gas Pipeline Co. of Am., 390 F.3d 366, 372 (5th Cir. 

2004); El Paso Field Servs., L.P. v. Mastec N. Am., Inc., 389 S.W.3d 802, 808 (Tex. 2012);

Union Pac. Res. Grp., Inc. v. Hankins, 111 S.W.3d 69, 71 (Tex. 2003).

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