# IN THE SUPREME COURT O F TEX AS

4 4 4 4 4 4 4 4 4 4 4 4 

## N O



## . 14-0302

4 4 4 4 4 4 4 4 4 4 4 4


# C H E S A P E A K E 

# E X P L O R A T IO N 

# , L

. L

. C

. A N D 

# C H E S A P E A K E 

# O P E R A T IN G 

# , I N C



# . , P E T IT IO N E R S 

# ,

v
. 

# M A R T H A 

# R O W A N 

# H Y D E R 

# , I N D IV ID U A L L Y 

# , A N D A S 

# I N D E P E N D E N T 

# E X E C U T R IX A N D 

# T R U S T E E U N D E R T H E 

# W IL L O F 

# E L T O N 

# M

. H Y D E R 

# , J R



# . , D E C E A S E D 

# , A N D A S 

# T R U S T E E U N D E R T H E 

# E L T O N 

# M

. H Y D E R 

# J R



# . R E S ID U A R Y 

# T R U S T 

# , A N D A S 

# T R U S T E E O F T H E 

# E L T O N 

# M

. H Y D E R 

# J R



# . M A R IT A L 

# T R U S T 

# ; B R E N T 

# R O W A N 

# H Y D E R 

# , I N D IV ID U A L L Y A N D A S 

# T R U S T E E O F T H E 

# C H A R L E S 

# H Y D E R 

# T R U S T A N D A S 

# T R U S T E E O F T H E 

# G E O F F R E Y 

# H Y D E R 

# T R U S T 

# ; W H IT N E Y 

# H Y D E R 

# M O R E 

# , I N D IV ID U A L L Y A N D A S 

# T R U S T E E O F T H E 

# E L T O N 

# M A T T H E W 

# H Y D E R 

# I V T R U S T 

# , A S 

# T R U S T E E O F T H E 

# P E T E R 

# R O W A N 

# M O R E 

# T R U S T 

# , A S 

# T R U S T E E O F T H E 

# L IL I 

# L O W D O N 

# H Y D E R 

# T R U S T 

# , A N D A S 

# T R U S T E E O F T H E 

# S A M U E L 

# D O U G L A S 

# M O R E 

# T R U S T 

# ; A N D



# H Y D E R 

# M IN E R A L S 

# , L T D



# . , R E S P O N D E N T S

4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4



## O N 

## P E T I T I O N F O R 

## R E V I E W F R O M T H E 

## C O U R T O F 

## A P P E A L S F O R T H E 

## F O U R T H 

## D I S T R I C T O F 

## T E X A S



### 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 

## Argued Mar ch 24, 2015

C H I E F 

## J U S T I C E 

## H E C H T 

## delivere d the opinion of the Court, in which J U S T I C E 

## G R E E N 

## , J U S T I C E 

## J O H N S O N 

## , J U S T I C E 

## B O Y D 

## , and J U S T I C E 

## D E V I N E 

## joined.

J U S T IC E 

## B R O W N 

## f

il e d a dissenting opinion, in which J U S T I C E 

## W I L L E T T 

## , J U S T I C E 

## G U Z M A N 

## a n d J U S T I C E 

## L E H R M A N N 

## joined.

Gene rally speaking , an overr iding roy alty on oil and g as p roduction is fre e of production

costs but must bear its share of postproduction costs unless the p arties ag ree otherwise. The only

## question in t h i s case is whether the parties’ lease expresses a differ ent agr eeme nt. We conclude it

does and the ref

ore a ffirm the c ourt of appe als’ judg ment. 1



## The Hy der f

amily lease d 948 mineral acr es in the Ba rnett Shale. Chesapea

ke Ex ploration, 2



## L

. L

. C

. , ac quired the lessee’ s interest. The lease was neg otiated and draf ted by counsel for th e 3


## Hy ders a nd the orig inal lessee.
The lease contains three roy alty provisions. One is for 25% of “the marke t value at the well
of all oi l and other liquid hy droca rbons”. No oil is produce d from the lea se. Another roy alty is for
25% “of the price actua lly rec eived by L essee ” for all g as produced from the l ea s ed p re m ises and
sold or used. The lease adds that the roy alty is expressly “fr ee and clea r of all production and post- 4 

## production costs and ex penses,” an d l i s t s examples of various expenses. The thi rd provisi on, the 5



## one here in dispute, calls for “a perpe tual, cost-fr ee (e x cept only its portion of production taxes)

4 2 7 S

. W

. 3 d 4 7 2 ( T e x
. A p p

. — S a n A n t o n i o 2 0 1 4 )

. 1

T h e H y d e r r e s p o n d e n t s i n c l u d e M a r t h a R o w a n H y d e r , i n d i v i d u a l l y a n d a s i n d e p e n d e n t e x e c u t r i x a n d t r u s t e e 2

u n d e r t h e W i l l o f

E l t o n M

. H y d e r J r

. , d e c e a s e d , a s t r u s t e e u n d e r t h e E l t o n M

. H y d e r J r

. R e s i d u a r y T r u s t , a n d a s t r u s t e e o f t h e E l t o n M

. H y d e r J r

. M a r i t a l T r u s t ; B r e n t R o w a n H y d e r , i n d i v i d u a l l y a n d a s t r u s t e e o f t h e C h a r l e s H y d e r T r u s t a n d
a s t r u s t e e o f t h e G e o f

f r e y H y d e r T r u s t ; W h i t n e y H y d e r M o r e , i n d i v i d u a l l y a n d a s t r u s t e e o f t h e E l t o n M a t t h e w H y d e r I V T r u s t , a s t r u s t e e o f t h e P e t e r R o w a n M o r e T r u s t , a s t r u s t e e o f t h e L i l i L o w d o n H y d e r T r u s t , a n d a s t r u s t e e o f t h e S a m u e l D o u g l a s M o r e T r u s t ; a n d H y d e r M i n e r a l s , L t d

. W e r e f e r t o t h e l e s s o r s a s t h e H y d e r s

.
P e t i t i o n e r s a r e C h e s a p e a k e E x p l o r a t i o n , L

. L

. C

. , a n d a n a f f i l i a t e t h a t a c t s a s i t s a g e n t f o r a l l n a t u r a l g a s 3

o p e r a t i o n s o n t h e p r o p e r t y , C h e s a p e a k e O p e r a t i n g , I n c

. W e r e f e r t o t h e m c o l l e c t i v e l y a s C h e s a p e a k e

.
T h e l e a s e p r o v i d e s t h a t t h i s r o y a l t y i s “ f o r n a t u r a l g a s , i n c l u d i n g c a s i n g h e a d g a s a n d o t h e r g a s e o u s s u b s t a n c e s 4 p r o d u c e d f

r o m t h e L e a s e d P r e m i s e s a n d s o l d o r u s e d o n o r o f f t h e L e a s e d P r e m i s e s ” a n d t h a t “ [ i ] n n o e v e n t s h a l l t h e
v o l u m e o f g a s u s e d t o c a l c u l a t e L e s s o r s ’ r o y a l t y b e r e d u c e d f o r g a s u s e d b y L e s s e e a s f u e l f o r l e a s e o p e r a t i o n s o r f o r c o m p r e s s i o n o r d e h y d r a t i o n o f g a s

. ”

T h e r o y a l t y p r o v i s i o n c o n t i n u e s : “ i n c l u d i n g b u t n o t l i m i t e d t o , p r o d u c t i o n , g a t h e r i n g , s e p a r a t i n g , s t o r i n g , 5 d e h y d r a t i n g , c o m p r e s s i n g , t r a n s p o r t i n g , p r o c e s s i n g , t r e a t i n g , m a r k e t i n g , d e l i v e r i n g , o r a n y o t h e r c o s t s a n d e x p e n s e s i n c u r r e d b e t w e e n t h e w e l l h e a d a n d L e s s e e ’ s p o i n t o f d e l i v e r y o r s a l e o f s u c h s h a r e t o a t h i r d p a r t y
. L e s s o r ’ s r o y a l t y s h a r e s h a l l a l s o b e f

r e e a n d c l e a r o f a l l c o s t s o f c o n s t r u c t i o n , o p e r a t i o n o r d e p r e c i a t i o n o f a n y p l a n t o r o t h e r f a c i l i t i e s o r e q u i p m e n t u s e d f

o r p r o c e s s i n g o r t r e a t i n g p a i d p r o d u c t i o n

. ”


### 2

## overr iding roy alty of five perc ent (5.0%) of g ross production obtained” from direc tional wells drilled

on the lease but bottomed on nearby land. The lease contains two other provisions r eleva nt to our 6



## consideration. One is this disclaimer: “L essors and L essee ag ree that the holding in the case of Heritage Resource

s, Inc. v. NationsBank , 939 S.W

. 2d 118 (Tex. 1996) shall have no application to
the terms and provisions of this L ease .” The other is that “ea ch L essor has the continuing rig ht and option to take its roy alty share in kind”. No lessor has ever exercised that rig ht. Whil e the overr iding

roy alty appea rs to be in kind, the par

ties do not disagr ee tha

t it can be pa id in money

. The Hy ders and Chesapea ke ag ree that the overr iding roy alty is fre e of production costs; they dispute whether it is also fre e of postproduction cost s

. T here are twenty -nine producing g as wells

on the lease d or pooled land, seven of which are direc tional wells bottomed on and producing from
lands not subject to the lease

. Chesapea ke sells all the g as produce d to an af fi l i at e, Chesapea

ke Energ y Marke ting, I nc. (“Ma rketing ”), which then g at h er s and transports the g as throug h both
aff iliated and int e r s ta

te pipelines for sale to third-par ty purcha sers in distant marke ts. Marke ting pay s Chesapea ke a “g as purcha se price ” for volumes deter mined at the wellhea d o r— d u ri ng ear lier periods—at the terminus of Marke ting’ s g ather ing s y s te m. T h e g a s p u rcha se price is calc ulated based

on a weig hted aver ag e of the third-par t y s al es price s rec eived (the “g as sales price ”) less

T h e l e a s e s t a t e s t h a t “ L e s s e e s h a l l , w i t h i n s i x t y ( 6 0 ) d a y s f r o m t h e d a t e o f f

i r s t p r o d u c t i o n f

r o m e a c h 6 [ d i r e c t i o n a l ] w e l l , c o n v e y t o L e s s o r s ” t h e o v e r r i d i n g r o y a l t y
. T h e p a r t i e s t r e a t t h i s r o y a l t y p r o v i s i o n l i k e a c o n v e y a n c e , a n d s o d o w e

. O n l y t w o o f t h e r e s p o n d e n t s , B r e n t R o w a n H y d e r a n d W h i t n e y H y d e r M o r e , a r e a l l e g e d t o o w n o v e r r i d i n g
r o y a l t i e s

. B e c a u s e a l l r e s p o n d e n t s j o i n i n t h e a r g u m e n t s m a d e h e r e , w e r e f e r t o t h e o v e r r i d i n g r o y a l t i e s a s d u e t o t h e H y d e r s

. 

### 3

## postproduction costs. The overr iding roy alty Chesapea ke pay s the Hy ders is 5% of the g as purcha se 7 

## price . The Hy ders c ontend that their ove rriding roy alty should be based on the g as sales pr ice.
After a bench trial, the trial court rende red judgme n t for the Hy ders, awa rding them $575,359.90 in postproduction costs that Chesapea ke wrong fully deducte d fr om their overr iding

roy alty . The c ourt of appe als aff irmed. We gr anted Chesa peake ’s petition for re view. 8 9



## I n Heritage Resource

s, Inc. v. NationsBank , we noted that a roy alty is fre e of production

expenses but “usually subject to po s t -p ro d u ct ion costs, including taxes

. . . and transporta tion

costs.” But we added that “the parties may modify this g ener al rule by ag ree ment.” We long ag o

1 0 1 1



## define d an overr iding roy alty as “a g iven perc entag e of the g ross production car ved from the working
interest but, by ag ree ment, not char g eable with any of the expenses of opera tion.” That ag ree ment 1 2



## is now understood to be part of an overr iding roy alty , and an overr iding roy alty is like a landowner ’s

M a r k e t i n g d e d u c t s , a s p o s t p r o d u c t i o n c o s t s , g a t h e r i n g a n d t r a n s p o r t a t i o n c o s t s a n d a 3 % m a r k e t i n g f e e

. 7

4 2 7 S

. W

. 3 d 4 7 2 ( T e x
. A p p

. — S a n A n t o n i o 2 0 1 4 )

. 8

5 8 T e x
. S u p

. C t

. J

. 2 2 7 ( J a n

. 3 0 , 2 0 1 5 )

. 9

9 3 9 S

. W

. 2 d 1 1 8 , 1 2 1

– 1 2 2 ( T e x
. 1 9 9 6 ) ; a c c o r d F r e n c h v

. O c c i d e n t a l P e r m i a n L t d

. , 4 4 0 S

. W

. 3 d 1 , 3 ( T e x
. 10 2 0 1 4 )

.
H e r i t a g e R e s

. , 9 3 9 S

. W

. 2 d a t 1 2 2 ; a c c o r d F r e n c h , 4 4 0 S

. W

. 3 d a t 3

.

11

M a c D o n a l d v

. F o l l e t t , 1 8 0 S

. W

. 2 d 3 3 4 , 3 3 6 ( T e x
. 1 9 4 4 )

. 12



### 4

## roy alty in that it usually bear s postproduction costs but not production costs, though the parties may 1 3



## ag ree to a diffe rent a

rra ng ement. 1 4



## Two of the roy alty provisions in the Hy der–Chesa peake lease are clea

r. The oil roy alty bear s postproduction costs beca use it is paid on the marke t value of the oil at the well. The marke t value 1 5



## at the well should equal the commerc ial marke t value less the proce ssing and transporting expenses that must be paid befor e the g as re ache s the commerc ial marke t. 1 6



## The g as roy alty in the lease does not bear p ostproduction costs beca use it is based on the price Chesapea

ke actua lly rec eives for the g as throug h its aff iliate, Marke ting, afte r postproduction

costs have been paid. Often ref err ed to as a “proc eeds lease ”, the price -re ceive d basis for pay ment 1 7



## is sufficie nt in itself to excuse the lessors from bear ing postproduction costs. And of course , like any

S e e P a r a d i g m O i l
, I

n c

. v

. R e t a m c o O

p e r a t i n g , I

n c

. , 3 7 2 S

. W

. 3 d 1 7 7 , 1 8 0 n

. 1 ( T e x
. 2 0 1 2 ) ( “ A n o v e r r i d i n g 13

r o y a l t y i s a n i n t e r e s t i n t h e o i l a n d g a s p r o d u c e d a t t h e s u r f a c e , f r e e o f t h e e x p e n s e o f p r o d u c t i o n

. ” ( i n t e r n a l q u o t a t i o n
m a r k s o m i t t e d ) ) ; s e e a l s o A l a m o N

a t ’ l B a n k v

. H u r d , 4 8 5 S

. W

. 2 d 3 3 5 , 3 3 9 ( T e x
. C i v
. A p p

. — S a n A n t o n i o 1 9 7 2 , w r i t
r e f ’ d n

. r

. e

. ) ( “ A n o v e r r i d i n g r o y a l t y i s f i r s t a n d f o r e m o s t a r o y a l t y i n t e r e s t

. I n o t h e r w o r d s , i t i s a n i n t e r e s t i n o i l a n d g a s p r o d u c e d a t t h e s u r f

a c e , f r e e o f t h e e x p e n s e s o f p r o d u c t i o n

. ” )

.
S e e H e r i t a g e R e s

. , 9 3 9 S

. W

. 2 d a t 1 2 2 ( n o t i n g t h a t p a r t i e s m a y a g r e e t o m o d i f y t h e g e n e r a l r u l e t h a t a r o y a l t y , 14 t h o u g h n o t s u b j e c t t o p r o d u c t i o n c o s t s , i s s u b j e c t t o p o s t p r o d u c t i o n c o s t s ) ; 8 H

. W IL L IA M S & C

. M E Y E R S , O IL A N D G A S L A W : M A N U A L O F O IL A N D G A S T E R M S 7 3 1 ( 2 0 1 4 ) ( “ O n e o f t h e m o s t i m p o r t a n t a s p e c t s o f a n ‘ o v e r r i d i n g r o y a l t y ’

. . . i s t h a t i t i s a ‘ r o y a l t y , ’ v i z
. , i n t h e a b s e n c e o f a n e x p r e s s a g r e e m e n t t o t h e c o n t r a r y i t i s f r e e o f c o s t s o f w h i c h t h e l e s s o r ’ s
r o y a l t y i s f

r e e a n d i t i s s u b j e c t t o t h e c o s t s t o w h i c h t h e l e s s o r ’ s r o y a l t y i s s u b j e c t

. ” )

.
S e e H e r i t a g e R e s

. , 9 3 9 S

. W

. 2 d a t 1 2 2

. 15

I d

. 16

C h e s a p e a k e d o e s n o t d i s p u t e t h a t “ t h e p r i c e a c t u a l l y r e c e i v e d b y t h e L e s s e e ” f o r p u r p o s e s o f

t h e g a s r o y a l t y 17 i s t h e g a s s a l e s p r i c e i t s a f f i l i a t e , M a r k e t i n g , r e c e i v e d , n o r d o t h e H y d e r s a r g u e t h a t t h e g a s s a l e s p r i c e w a s u n f a i r

. C f

. P h i l l i p s P e t r o l e u m C o

. v

. Y

a r b r o u g h , 4 0 5 S

. W

. 3 d 7 0 , 7 8 ( T e x
. 2 0 1 3 ) ( “ A d u t y t o m a r k e t i s i m p l i e d i n l e a s e s t h a t b a s e
r o y a l t y c a l c u l a t i o n s o n t h e p r i c e r e c e i v e d b y t h e l e s s e e f o r t h e g a s

. Y

z a g u i r r e v

. K C S R e s

. , I n c

. , 5 3 S

. W

. 3 d 3 6 8 , 3 7 3

– 7 4 ( T e x
. 2 0 0 1 )

. ” )

.



### 5

## other roy alty , the g as roy alty does not share in production costs. But the roy alty provision expressly

adds that the g as roy alty is “fr ee and clea r of all production and post-production costs and expenses,”
and then g oes further by listi ng them. This addition has no eff ect on the meaning of the provision. 1 8



## I t might be r eg arde d as empha siz ing the cost-fr ee nature of the g as roy alty , or as surplusa g e. The overriding roy alty in the Hy der–Chesa peake lease is not as clear as either of the ot her

two roy alty provisions. The Hy ders arg ue that the require ment that the overr iding roy alty be “costfre e” can only ref

er to postproduction costs, since the roy alty is by nature alre ady fre e of production

costs without say i n g s o

. Bu t as with the g as roy alty , “cost-f ree ” may simply emphasize that the

overr iding roy alty is fre e of production costs. Chesapea ke arg ues that “cost-f

ree overr iding roy alty ”
is mere ly a sy

nony m for overr iding roy alty , and a number of lease provisions discussed in other case s support that view. 1 9



## The exception for productio n taxes, which are postproduction expenses, cuts ag ainst 2 0 

## Chesapea ke’s arg ument. I t would make no sense to state that the roy alty is fre e of production costs,
except for postproduction taxes (no dogs allowed, except for cats). The exception for tax es m ight
be taken to indicate that “cost-f ree ” ref ers onl y t o p o s t production costs. But a taxes exception to

T h e c o u r t o f a p p e a l s r e a s o n e d o t h e r w i s e , r e l y i n g o n t h e “ f r e e a n d c l e a r ” l a n g u a g e t o c o n c l u d e t h a t b o t h t h e 18

o i l a n d g a s r o y a l t i e s a r e f r e e o f p o s t p r o d u c t i o n c o s t s

. 4 2 7 S

. W

. 3 d a t 4 7 7

– 4 7 8

. C h e s a p e a k e h a s n o t c h a l l e n g e d t h a t r u l i n g i n t h i s C o u r t

.

S e e , e

. g

. , M c M a h o n v

. C h r i s t m a n n , 3 0 3 S

. W

. 2 d 3 4 1 , 3 4 3 ( T e x
. 1 9 5 7 ) ( l e a s e p r o v i d i n g a n “ o v e r r i d i n g r o y a l t y 19

. . . f r e e o f c o s t o r e x p e n s e ” ) ; R

. R

. C o m m ’ n v

. A m

. T r a d i n g & P r o d

. C o r

p

. , 3 2 3 S

. W

. 2 d 4 7 4 , 4 7 7 ( T e x
. C i v
. A p p

. — A u s t i n 1 9 5 9 , w r i t r e f ’ d n

. r

. e

. ) ( a g r e e m e n t r e s e r v i n g a n “ o v e r r i d i n g r o y a l t y o f 3 / 8 t h s o f 8 / 8 t h s o f a l l t h e o i l , g a s
a n d o t h e r m i n e r a l s p r o d u c e d a n d s a v e d f r o m s a i d l a n d s

. . . f

r e e o f a l l c o s t s , e x c e p t t a x e s ” ) ; M i d a s O i l C o

. v

. W h i t a k e r , 1 2 3 S

. W

. 2 d 4 9 5 , 4 9 5 ( T e x
. C i v
. A p p

. — E a s t l a n d 1 9 3 8 , n o w r i t ) ( a s s i g n o r ’ s r e t e n t i o n o f “ a n o v e r r i d i n g r o y a l t y o f 7 / 3 2
o f a l l o i l , g a s o r o t h e r m i n e r a l s

. . . f r e e o f c o s t t o h i m s e l f

” )

.
H e r i t a g e R e s

. , 9 3 9 S

. W

. 2 d a t 1 2 2

. 20



### 6

## fre edom from production costs is not uncommon in lease s, sug g esting only that lease draf ters are 2 1 

## not alway s driven by

logic

. We thus disag ree with the Hy ders that “cost-f ree ” i n t h e Hy der–Chesa peake overr iding

roy alty provision c annot ref

er to pr oduction costs. As noted above, draf ters fre quently specify

that

an overr iding roy alty does not bear production costs even though an overr iding roy alty is alre ady fre e of production costs simply beca use it is a roy alty

interest. But Chesa

peake must show that while 2 2



## the g ener al term “cost-f

ree ” does not distinguish betwee n production and postproduction costs and
thus lit era lly

ref ers to all costs, it never

theless ca nnot refe r to postproduction costs here

. Chesapea ke arg ues that beca

use the overr iding roy alt y i s p aid on “g ross production”, the
ref ere nce is to production at the wellhea d, making the roy alty tantamount to one based on the marke t
value o f p ro d u ction at the wellhea d, which bear s postproduction costs. “Gr oss” means “[u] ndiminis hed by

deduction; entire ”. We a g ree with Che sapea ke, as do the Hy ders, that “g ross 2 3 

## production” is the entire amount of g as produce d, including g as used by Chesapea ke or lost in postproduction opera tions. But the parties do not dispute that the overr iding roy alty may be paid in

ca s h an d n o t i n kind, though the Hy ders reta ined the rig ht to take it in kind. Specify ing that th e

S e e , e

. g

. , M a r t i n v

. G l a s s , 5 7 1 F

. S u p p

. 1 4 0 6 , 1 4 1 0 ( N

. D

. T e x
. 1 9 8 3 ) ; D e l t a D r i l l i n g C o

. v

. S i m m o n s , 3 3 8 21 S

. W

. 2 d 1 4 3 , 1 4 7 ( T e x
. 1 9 6 0 ) ; M c M a h o n , 3 0 3 S

. W

. 2 d a t 3 5 0 ; G r a h a m v

. P r o c h a s k a , 4 2 9 S

. W

. 3 d 6 5 0 , 6 5 3 ( T e x
. A p p

. — S a n A n t o n i o 2 0 1 3 , p e t

. f i l e d ) ; A m

. T

r a d i n g & P r o d

. C o r

p

. , 3 2 3 S

. W

. 2 d a t 4 7 7 ; W a h l e n m a i e r v

. A m

. Q u a s a r P e t r o l e u m C o

. , 5 1 7 S

. W

. 2 d 3 9 0 , 3 9 2 ( T e x
. C i v
. A p p

. — E l P a s o 1 9 7 4 , w r i t r e f ’ d n

. r

. e

. ) ; s e e a l s o Z e p h y r O i l C o

. v

. C u n n i n g h a m , 2 6 5 S

. W

. 2 d 1 6 9 , 1 7 2 ( T e x
. C i v
. A p p

. — F o r t W o r t h 1 9 5 4 , w r i t r e f ’ d n

. r

. e

. ) ( l e s s o r s o u g h t r e f o r m a t i o n o f
o v e r r i d i n g r o y a l t y t o i n c l u d e a s h a r e o f t h e v a l u e o f t h e g a s p r o d u c e d , l e s s p r o r a t a t a x e s p a i d o n t h e g a s )

.

S e e s u p r a n

. 1 9

. 22

B L A C K ’ S L A W D IC T IO N A R Y 8 1 8 ( 1 0 t h e d

. 2 0 1 4 )

. 23



### 7

## volume on which a roy alty is due mus t be determined at the wellhea d say s nothing about whether

the over riding roy alty

must bear postproduc tion costs.
This is clea

r from the other roy alty provisions. The oil roy alty is paid on all oil produce d and
bear s postproduction costs. The g as roy alty is due on all g as produce d and used or sold—that is, all

g as produce d except that lost befor e sale or use. The g as roy alty does not bear postproduction costs,
not be cause it is based on a volume other than full production, but be cause the amount is ba sed on the price actua lly

rec eived by

the lessee , not the marke t value at the w ell. Chesapea ke arg ues that the g as roy alty provision shows that when the parties wanted a postproduction-cost-f

ree roy alty , they wer e much more specific

. But as we have alre ady said, the
additional detail in the g as roy alty provision serve s on l y , if any thing, to emphasize its cost-fr ee

nature . The simple “c ost-fre e” r equire ment of the ove rriding roy alty achie ves the same end.
The overr iding roy alty provision rea ds as though the roy alty is in kind, but Chesapea ke does
not arg ue that it must be, and i n fac t the roy alty has alway s been paid in cash. W ere the Hy ders to
take their overr iding roy alty in kind, as they are entitled to do, they might use the g as on the proper ty , transport it themselves to a buy er, or pay a thi rd par ty to transport the g as to marke t as t hey might

neg otiate. I n any event, the Hy ders might or mi gh t not incur postproduction costs equal to those
char g ed by Marke ting. The lease g ives them that choice

. The same would be true of the g as roy alty , which is to be paid in cash but can be taken in kind. The fac t that the Hy ders might or might not be subject to postproduction costs by taking the g as in kind does not sug g est that they must be subject

to those costs when the roy alty is paid in cash. The choice of ho w t o take their roy alty , and the

8

## conseque nces, are left to the Hy ders. Acc ord ingly , we conclude that “cost-f ree ” in the overr iding

roy alty provision includes postproduction costs.
The Hy ders offe r another rea son for our c onclusion. They arg ue that the lea se’s disclaimer
of any application of the holding of Heritage Resource s shows that the parties intended an overr iding

roy alty fre e of postproduction costs. That case involved roy alty provisions based on the marke t value
of g as at the well wi t h “n o d ed u ctions from the value of the L essor’s roy alty by rea son of any ” postproduction costs. The Court concluded that the no-deductions phrase was unambiguous and 2 4



## ineffe ctive to f

r e e th e r o y alties from postproduction costs. J ustice Owen’ s concur ring opinion, which
beca me the plura lity

opinion for the Court, explained: 2 5



## There is littl e doubt that at least some of t h e p ar t i es to these ag ree ments subjectively intended the phrase at i ssue t o have meaning

. Howeve r, t he use of t he words “deduc tions from the value of L essor’s roy alty ” is circ ular in light of this and other co u rt s ’ interpre tation of “mar ket value at the well.” The conce pt of “deduc tions” of marke ting c osts from the value of the g as is me aning less when g as is va lued at the well. Value at the well is a lrea dy net of rea sonable marke ting costs. The value of g as “at the well” repr esents its value in the marke tplace at any gi v en point of sale, less the rea sonable cost to g et the g as to th at p o i n t o f sale, including compre ssion, transporta tion, and proce ssing costs. Evidence of marke t value is often compar able sales, as the Court indicates, or value can be proven by the so-ca lled net-ba ck approa ch, which deter mines the preva iling marke t price at a g iven point and backs out the nece ssary , rea sonable costs betwee n that point a nd the wellhea d. But, reg ardle ss of how value is proven in a court of law, logic and economics tell us that there are no marke ting c osts to “deduct” f rom value a t the wellhea d.

. . . .

H e r i t a g e R e s

. , 9 3 9 S

. W

. 2 d a t 1 2 0

– 1 2 1

. 24

J u s t i c e B a k e r i n i t i a l l y d e l i v e r e d t h e o p i n i o n f o r t h e C o u r t , j o i n e d b y C h i e f J u s t i c e P h i l l i p s , J u s t i c e C o r n y n , 25 J u s t i c e E n o c h , a n d J u s t i c e S p e c t o r

. I d

. a t 1 2 0

. J u s t i c e O w e n , j o i n e d b y t h e n - J u s t i c e H e c h t , c o n c u r r e d i n t h e j u d g m e n t

. I d

. a t 1 2 4

. J u s t i c e G o n z a l e z , j o i n e d b y J u s t i c e A b b o t t , d i s s e n t e d

. I d

. a t 1 3 1

. O n r e h e a r i n g , C h i e f J u s t i c e P h i l l i p s j o i n e d J u s t i c e O w e n , J u s t i c e C o r n y n a n d J u s t i c e S p e c t o r j o i n e d J u s t i c e G o n z a l e z , a n d J u s t i c e E n o c h r e c u s e d h i m s e l f

. 9 6 0 S

. W

. 2 d 6 1 9 , 6 2 0 ( T e x
. 1 9 9 7 ) ( G o n z a l e z , J

. , d i s s e n t i n g o n d e n i a l o f m o t i o n f o r r e h e a r i n g )

. 

### 9

## As long as “mar ket value at the well” is the be nchmar k for va luing the g as, a phrase prohibiting the deduction of post-production costs from that value does not chang e the meaning of the roy alty clause

. . . . All costs would alre ady be borne by the lessee. I t could not be said unde r that circ umstance that the clause is ambig uous. I t could only

be said that the pr oviso is surplusage

. 2 6



## Marke t value, if calc ulated without ref ere nce to fac tors nece ssary to that deter mination, is not marke t
value. Heritage Resource s does not sug g est, much less hold, that a roy alty cannot be made fre e of postproduction costs. Heritage Resource s holds only that the eff

ect of a lease is g overne d by a fair

rea ding of its text

. A disclaimer of that holding, like the one in this case , cannot fr ee a roy alty of postproduction costs when the text of the lease itself does not do so. Her e, the lease text clea rly fre es
the g as roy alty of postproduction costs, and rea sonably interpre ted, we conclude , does the same for

t h e o v er riding roy alty

. The disclaimer of Heritage Resource s ’ holding does not influence ou r
conclusion.

* * * * *
The c ourt of appe als’ judg ment is affirme d.

Nathan L . Hec ht Chief J ustice

Opinion delivere d: J une 12, 2015

9 3 9 S

. W

. 2 d a t 1 3 0

– 1 3 1 ( c i t a t i o n s o m i t t e d )

. 26



### 1 0