Opinion ID: 567657
Heading Depth: 2
Heading Rank: 1

Heading: royalty on take-or-pay settlement proceeds

Text: 8 The terms of a Louisiana mineral lease determine the obligations of its signatories. See Odom v. Union Producing Co., 243 La. 48, 141 So.2d 649, 656 (1961). Frey and Amoco dispute whether payments received by Amoco under its take-or-pay contract with Columbia are part of the amount realized from gas sold by Amoco. On cross-motions for summary judgment, the district court interpreted the Lease's gas royalty clause as requiring Amoco to account to Frey only for receipts attributable to specific gas production. The court considered the parties' contract dispute controlled by Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159, 1168 (5th Cir.1988) and granted Amoco partial summary judgment that it owes Frey no royalty on take-or-pay monies received from Columbia. Frey, 708 F.Supp. at 787. We review de novo the court's interpretation of the Lease's legal effect. FED.R.CIV.P. 56; USX Corp. v. Tanenbaum, 868 F.2d 1455, 1457 (5th Cir.1989).
9 In Diamond Shamrock, this court held that production, as used in a mineral lease prepared by the Department of Interior, means the actual physical severance of minerals from the ground. Diamond Shamrock, 853 F.2d at 1168. This holding made gas royalties under the lease there at issue due only on gas actually produced and not on take-or-pay payments received by the lessee-producer from the pipeline-purchaser. Id. 10 Several facts distinguish Diamond Shamrock from this case. Foremost, the cases concern different lease language. In Diamond Shamrock, the lessor received as royalty a fraction of the amount or value of production saved, removed, or sold whereas Frey is entitled to a fraction of the amount realized at the well from [the sale of gas]. Compare Diamond Shamrock, 853 F.2d at 1163 (emphasis added) with Frey, 708 F.Supp. at 786. Second, the Diamond Shamrock court applied federal law in determining the meaning of the Department of Interior leases there at issue, but we must predict how the Louisiana Supreme Court would allocate take-or-pay payments under the Lease. See, e.g., Piney Woods Country Life School v. Shell Oil Co., 905 F.2d 840, 851-52 (5th Cir.1990) (predicting that Mississippi Supreme Court would consider federal price ceilings in determining the meaning of market value in gas royalty contract). Finally, the Department of Interior as lessor wrote the Diamond Shamrock lease, while here, Amoco as lessee prepared the Lease and presented it to F & L for execution. So Diamond Shamrock does not control the result in this case. The Lease's paragraph 7(b) establishes 11 the royalty on gas sold by Lessee to be one-fifth ( 1/5) of the amount realized at the well from such sales. 12 The district court held that a 'sale' of gas cannot occur absent physical production and severance of the gas. Frey, 708 F.Supp. at 786. Though the court cited authority for the proposition that in Louisiana, gas apart from the mineral estate cannot be owned by the buyer until it is produced, see id., the court assumed that a thing must be owned to be sold. 1 However, under Louisiana law a 13 sale is sometimes made of a thing to come: as of what shall accrue from an estate, of animals yet unborn, or such like other things, although not yet existing. 14 LA.CIV.CODE ANN. art. 2450 (West 1952). More importantly, the court gives no explanation for why take-or-pay payments are not considered part of the total consideration for the right to take gas under the Morganza Contract. 15 The Lease affords royalty on the amount realized from sales, not on production. Cf. Diamond Shamrock, 853 F.2d at 1161; Killam Oil Co. v. Bruni, 806 S.W.2d 264, 266-67 (Tex.App.--San Antonio 1991, writ requested); State v. Pennzoil Co., 752 P.2d 975, 976 (Wyo.1988) (no royalty on take-or-pay payments where leases explicitly tie royalty to production). This court before has held that take-or-pay arrangements can effect a sale of gas that brings take-or-pay arrangements within the jurisdiction of the Federal Power Commission despite the possibility that the producer may not deliver any gas pursuant to arrangement. Callery Properties, Inc. v. Federal Power Comm'n, 335 F.2d 1004, 1021 (5th Cir.1964), rev'd on other grounds, 382 U.S. 223, 230, 86 S.Ct. 360, 364-65, 15 L.Ed.2d 284 (1965). That the Lease explicitly bases oil and miscellaneous mineral--but not gas--royalties on production strongly suggests that we not interpret production to be a prerequisite to royalties on gas. 2 See LA.CIV.CODE ANN. art. 2050 (West 1987) (each contractual provision must be interpreted in light of contract's other provisions). 16 Amoco contends that practical accounting difficulties should keep us from dividing recoupable take-or-pay payments between it and Frey. Amoco relies on the following Diamond Shamrock statement to support its argument: 17 [Requiring take-or-pay payments to be shared] would lead to absurd results. For example, if royalty is payable currently when the take-or-pay payment is made, what happens when the pipeline later takes make-up gas? If the fair market value of gas rises, the pipeline is usually responsible for paying for the make-up gas at the increased market value. The [lessor] gets its proportionate share of the increased market value as royalty for the make-up gas now taken. The lessee-producer then has to pay the additional royalty due on the increased fair market value, necessitating two royalty payments on one purchase of gas. 18 If the price of gas drops, depending on the contract, the pipeline-purchaser could be due a refund. If the pipeline gets a refund, then certainly it would be equitable for the lessee-producer to get a refund on overpaid royalties. A problem arises here with the length of the make-up period, usually 7 years, being longer than the statute of limitations [applicable to lessees' royalty refund claim]. In this situation, it is quite possible that the producers would never be able to recover overpaid royalties on take-or-pay payments. 19 Diamond Shamrock, 853 F.2d at 1166 (footnotes omitted). If the Lease language and Louisiana law require Frey to share in take-or-pay payments, we could not hold otherwise simply because Amoco could have to send two checks to Frey instead of one if the market value of gas rises when Columbia takes it. 3 20 On the facts of this case, we reject the possibility that a drop in market demand and price between the time that a pipeline submits a take-or-pay payment and recoups the gas could necessitate a refund from the lessor who shares in take-or-pay payments. Columbia paid Amoco approximately $45.6 million as a recoupable take-or-pay payment under the Settlement Agreement and in exchange, was allowed to take $45.6 million worth of gas over five years. The Settlement Agreement establishes the price for each thousand cubic feet (MCF) of gas recouped by Columbia during this period, so here the volume of gas taken, not the price paid, varied with market price over the make-up period. Thus, no refund from Frey could have been necessary under the Settlement Agreement. 4 21 We notice another argument worth consideration, but not raised by Amoco. The words amount realized at the well from [gas] sales could indicate that Amoco and F & L understood that Amoco would pay royalties only on amounts it received for gas physically present at the well and that gas could only be present at the well during production. But, again, the Lease demonstrates that Amoco knew how to make royalties explicitly dependent on production but did not do so. Rather than inferring a production requirement from the Lease's at the well language, we interpret this term-of-art according to its received meaning in the oil and gas industry. Kavanaugh v. Berkett, 407 So.2d 645, 647 (La.1981); see also LA.CIV.CODE ANN. art. 2047 (West 1987) (Words of art and technical terms must be given their technical meaning when the contract involves a technical matter.). Before at the well became widely used in gas leases, Louisiana courts held that the value of gas was to be determined at the well absent a lease provision to the contrary. Sartor v. Arkansas Natural Gas Corp., 321 U.S. 620, 622, 64 S.Ct. 724, 726, 88 L.Ed. 967 (1944). Later, to allocate refining and transportation costs among the lessor and lessee, parties specified the place at which gas is to be valued for royalty purposes. See Merritt v. Southwestern Elec. Power Co., 499 So.2d 210, 214 (La.Ct.App.1986). When we questioned Amoco's counsel about the significance of the term at the well during oral argument, he did not contend that this language did anything other than allocate gas transportation and marketing costs between Amoco and F & L.
22 Because Amoco and F & L did not specifically address whether take-or-pay payments are part of the amount realized from the sale of gas and because the Lease does not base gas royalties on production, we interpret the Lease's gas royalty clause in a manner consistent with the Lease's object and nature. LA.CIV.CODE ANN. arts. 2048, 2053 (West 1987); Henry v. Ballard & Cordell Corp., 418 So.2d 1334, 1339 (La.1982). We glean the nature and objective of a gas lease from Louisiana's Supreme Court: 23 Where the mineral lease provides for payment to the lessor of a fractional royalty interest, the lease arrangement is in the nature of a cooperative venture: the lessor contributes the land and the lessee the capital and expertise necessary to develop the minerals for the mutual benefit of both parties .... 24 ... The ultimate objective of the royalty provisions of a lease is to fix the division between the lessor and lessee of the economic benefits anticipated from the development of the minerals. 25 Id. at 1338 (emphasis added). The court cites with approval Professor Harrell's statement that 26 any determination of the market value of gas which ... permits either the lessor or lessee to receive a part of the gross revenues from the property greater than the fractional division contemplated by the lease, should be considered inherently contrary to the basic nature of the lease and be sustained only in the clearest of cases. 27 Id., at 1338 n. 10, quoting Harrell, Developments in Non Regulatory Oil & Gas Law, The 30th Annual Institute on Oil & Gas Law & Taxation, Southwestern Legal Foundation, 336 (1979) (emphasis added). 28 We think that Louisiana's Supreme Court would hold take-or-pay payments to be part of the amount realized from the sale of gas under the Lease. Amoco secured the right to take-or-pay payments only by executing a contract to sell the gas that Amoco acquired pursuant to the Lease. The payments, like the market price paid for gas taken, constitute economic benefits that Amoco received from granting Columbia the right to take gas from the leased premises, a right that Amoco got through the Lease. 5 It would be contrary to the nature of the lease as a cooperative venture to allow a benefit by any name that is attributable to the gas under the leased premises to inure exclusively to the lessee. 6 29 Although Louisiana courts have not decided the take-or-pay question presented by this case, our interpretation of the Lease accords with several aspects of Louisiana mineral jurisprudence in addition to Henry. In Louisiana, 30 [a] mineral lessee ... is bound to perform the contract in good faith and to develop and operate the property leased as a reasonably prudent operator for the mutual benefit of himself and his lessor. 31 LA.REV.STAT.ANN. § 31:122 (West 1989) (emphasis added). This statute obligates Amoco to exercise reasonable diligence to secure a market for gas that it discovers under leased property. See Shell Oil Co. v. Williams, Inc., 428 So.2d 798, 803 (La.1983). 32 If lessors did not share in take-or-pay payments, lessees would have an incentive to compromise volume gas prices under their contracts or settlements with pipelines in exchange for favorable take-or-pay terms. White, The Right To Recover Royalties on Natural Gas Take-Or-Pay Settlements, 41 OKLA.L.REV. at 670-72; Comment, Royalty on Take-or-Pay Payments and Related Considerations Accruing to Producers, 27 HOUSTON L.REV. 105, 134 n. 225 (1990); see also Amoco Production Co. v. First Baptist Church of Pyote, 579 S.W.2d 280, 287 (Tex.Civ.App.--El Paso 1979, writ ref'd n.r.e.) (lessee who compromises volume gas price for benefits that did not accrue to lessors is accountable to lessors). No law or typical lease term assures royalty owners of representation in negotiations between lessees and pipelines; Frey was not represented in negotiations between Amoco and Columbia. Given the duty imposed on lessees by R.S. 31:122, we will not countenance a conflict-of-interest in a lease as to marketing strategy, especially where the lease's language is equivocal or supports a reading that does not countenance a conflict. 33 The Louisiana Supreme Court's decision in Wemple v. Producers' Oil Co., 145 La. 1031, 83 So. 232 (1919) also supports our interpretation of the Lease. The lease at issue in Wemple provided a royalty of one-eighth of oil saved and produced and $200 per well per year for gas if any is used off of the leased premises. After the Wemple lease's execution, the lessee became aware of and employed a new oil production technology that indisputably produced more oil than any other available process. The new pumping method also efficiently drew casinghead gas from the well, which the lessee condensed to produce natural gasoline, a product not addressed in the Wemple lease. The lessee cited its right to produce oil under the lease and the efficiency of its chosen method in contending that it owned all rights to the natural gasoline by-product of its production process. The Wemple court disagreed. It applied equity principles to decide that the lessor cannot be presumed to have given away a valuable right arising from the leased premises for nothing in return and that both the lessor and the owner [are] entitled to be benefited by the lucrative, new production technology not addressed in the lease. Id. at 1045-48, 83 So. at 237-38; see also LA.CIV.CODE ANN. arts. 2053, 2055 (West 1987) (vague contracts subject to equitable interpretation). 34 If not covered by the Lease's amount realized language, take-or-pay payments, like the casinghead gas at issue in Wemple, would constitute a benefit derived from the leased premises that the parties did not explicitly allocate in the Lease, but which Amoco would inequitably keep for itself. Finally, our interpretation of the Lease against Amoco accords with LA.CIV.CODE ANN. art. 2056 (West 1987): [i]n case of doubt that cannot be otherwise resolved, a provision in a contract must be interpreted against the party who furnished its text. 35 We reverse the district court's summary judgment for Amoco on take-or-pay issues and hold that the plaintiffs are entitled to their share of one-fifth of all take-or-pay payments received by Amoco that are attributable to the leased premises. On remand, the district court will calculate the amounts due. 36