Opinion ID: 1862385
Heading Depth: 2
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Heading: Louisiana Mineral Law

Text: Ownership of land does not include ownership of oil or gas. [7] LA.REV. STAT. ง 31:6; Succession of Doll v. Doll, 593 So.2d 1239 (La.1992); Frost-Johnson Lumber Co. v. Salling's Heirs, 150 La. 756, 91 So. 207 (1920). The vesting of title to fugitive minerals, such as oil or gas, occurs when the minerals are reduced to possession at the wellhead. See LA.REV. STAT. ง 31:7 and the comment thereto; Texas Co. v. Fontenot, 200 La. 753, 8 So.2d 689 (1942); Wall v. United Gas Public Service Co., 178 La. 908, 152 So. 561 (1934); Frost-Johnson, supra . Thus, with respect to oil and gas, possession marks both the vesting of title and mobilization. LA.REV. STAT. ง 31:7, comment. See generally, Steele v. Denning, 445 So.2d 94 (La.App. 2d Cir.), aff'd, 456 So.2d 992 (La.1984); Succession of Rugg, 339 So.2d 519 (La. App. 2d Cir.1976), writ denied, 341 So.2d 897 (La.1977). Although the right to explore and develop one's property for the production of minerals, and to reduce minerals to possession and ownership, belongs exclusively to the landowner, LA.REV.STAT. ง 31:6, the landowner may convey, reserve or lease this privilege. LA.REV.STAT. ง 31:15; Succession of Doll, supra . See also Allies Oil Co. v. Ayers, 152 La. 19, 92 So. 720 (1922). In this manner, rights in minerals may be considered separable component parts of the ownership of land. A.N. Yiannopoulos, Property ง 118, in 2 Louisiana Civil Law Treatise (3d ed. 1991) (footnote omitted). A mineral lease, one of the manners in which mineral rights are segregated from ownership, id., is a contract by which the lessee is granted the right to explore for and produce minerals. LA.REV.STAT. ง 31:114; Succession of Doll, supra . Mineral leases are construed as leases generally and, wherever pertinent, codal provisions applicable to ordinary leases are applied to mineral leases. Succession of Doll, supra ; Melancon v. Texas Co., 230 La. 593, 89 So.2d 135 (1956). See also LA.REV.STAT. ง 31:2; McCollam, A Primer for the Practice of Mineral Law Under the New Louisiana Mineral Code, 50 Tul.L.Rev. 729, 733 (1976); L. McDougall, Louisiana Oil and Gas Law ง 3.1 (1991) and the authority cited therein. Accordingly, where the Louisiana Mineral Code, see LA.REV.STAT. ง 31:1-ง 31:215, neither expressly nor impliedly provides for a particular situation, resort is made to the Louisiana Civil Code or other laws, either directly or by analogy. LA.REV.STAT. ง 31:2 and the comment thereto. See, e.g., McCollam, 50 Tul.L.Rev. at 862 (The Mineral Code does not address gas purchase contracts). However, where there is conflict between the provisions of the Civil Code or other laws, the Mineral Code prevails. LA.REV.STAT. ง 31:2. See, e.g., Producers Oil & Gas Co. v. Nix, 488 So.2d 1099 (La.App. 2d Cir.), writ denied, 493 So.2d 641 (La.1986). We begin with the Mineral Code. Article 213(5) of the Mineral Code defines royalty, as used in conjunction with mineral leases, [8] as: any interest in production, or its value, from or attributable to land subject to mineral lease, that is deliverable or payable to the lessor or others entitled to share therein. Such interests in production or its value are `royalty,' whether created by the lease or by separate instrument, if they comprise a part of the negotiated agreement resulting in execution of the lease. `Royalty' also includes sums payable to the lessor that are classified by the lease as constructive production. Although Article 213(5) provides a standard for interpretation of the mineral lease, the rather expansive definition of royalty is not dispositive of the lessor's right to a royalty share of take-or-pay payments. See LA.REV.STAT. ง 31:122, comment, La. Civ.Code art. 2047. The principle of freedom of contract is expressly recognized by the Mineral Code, see LA.REV.STAT. ง 31:3, and therefore, the accessorial right of royalty may not be defined absent reference to the oil and gas lease in which it appears. See Vincent v. Bullock, 192 La. 1, 187 So. 35 (1939) (citing La.Civ.Code art. 1945 (1870)); H. Daggett, Mineral Rights in Louisiana ง 61 (1949); L. McDougall at ง 3.1. Accordingly, this Court must give consideration to the fundamental principle that the lease contract is the law between the parties, defining their respective legal rights and obligations, [9] see La.Civ.Code art. 1983; Odom v. Union Producing Co., 243 La. 48, 68, 141 So.2d 649, 656 (1961); Mallett v. Union Oil & Gas Corp. of Louisiana, 232 La. 157, 161, 94 So.2d 16, 17 (1957), as well as the rules for interpretation of contracts as laid down in the Civil Code, Title IV at Chpt. 13, art. 2045 et seq. Disinclined to rewrite a mineral lease in pursuit of equity, we are nonetheless cognizant the terms of a mineral lease are neither intended to, nor capable of, accommodating every eventuality. See Martin, A Modern Look at Implied Covenants To Explore, Develop, and Market Under Mineral Leases, 27 Inst. on Oil & Gas L. & Tax'n 177,194 (1976). The purpose of interpretation is to determine the common intent of the parties. See La.Civ.Code art. 2045. Words of art and technical terms must be given their technical meaning when the contract involves a technical matter, see La.Civ.Code art. 2047, and words susceptible of different meanings are to be interpreted as having the meaning that best conforms to the object of the contract. See La.Civ.Code art. 2048. A doubtful provision must be interpreted in light of the nature of the contract, equity, usages, the conduct of the parties before and after the formation of the contract, and other contracts of a like nature between the same parties. La.Civ. Code art. 2053. When the parties made no provision for a particular situation, it must be assumed that they intended to bind themselves not only to the express provisions of the contract, but also to whatever the law, equity, or usage regards as implied in a contract of that kind or necessary for the contract to achieve its purpose. La.Civ.Code art. 2054. To these basic concepts, we add one other. In Louisiana, a mineral lease is interpreted so as to give effect to the covenants implied in every such lease. See LA.REV.STAT. ง 31:122. Under the facts before us, a search for the parties' specific intent relative to the obligation to pay royalty on the take-or-pay proceeds would prove fruitless. Surely neither Amoco nor Frey contemplated at the time the Lease was executed in 1975 the demand for gas would fall and pipelines would be financially unable to comply with their obligations under long-term gas purchase and sales contracts. It is even more unlikely the parties contemplated producers would receive take-or-pay payments in settlement of gas contract litigation. Accordingly, we look not at the parties' intent to provide expressly for take-or-pay payments, but rather at the parties general intent in entering an oil and gas lease, viz., the lessor supplies the land and the lessee the capital and expertise necessary to develop the land for the mutual benefit of both parties. In this manner, the royalty clause is given an expansive reading, reflecting the mutuality of objectives and sharing of benefits inherent in the lessee-lessor relationship. See, e.g., Wemple v. Producers' Oil Co., 145 La. 1031, 83 So. 232 (1919). Consequently, we endeavor to ascertain the meaning of the royalty clause in a manner consistent with the nature and purpose of an oil and gas lease, La.Civ. Code art. 2054, having due regard for: 1) the function of a royalty clause; and 2) the lessee's implied obligation under Mineral Code Article 122 to market diligently the gas produced.
As stated, the royalty clause is construed not in the abstract but in reference to the economic and practical considerations underlying the royalty interest and with due regard to the relationship between a lessor and lessee. The lessor-lessee relationship ensues from a synallagmatic contract in which the obligation of each party is the cause of the other. See LA.REV.STAT. ง 31:122; La.Civ.Code arts. 1908, 1967, 2669; Wier v. Grubb, 228 La 254, 268, 82 So.2d 1, 6 (1955) (oil and gas leases require mutuality of rights and interest). Where royalty is conferred by the lease, royalty is the reason or cause for the lessor to obligate himself thereto. See La. Civ.Code art. 1967. Stated differently, royalty is the compensation or consideration the lessee pays to the lessor to secure the privilege of exercising the right to explore and develop the property for production of oil and gas. See Caddo Oil & Mining Co. v. Producers' Oil Co., 134 La. 701, 64 So. 684 (1914); H. Daggett at ง 60; R. Hemingway, The Law of Oil and Gas ง 8.1 (3d ed. 1991). By virtue of the beneficial relationship between lessee and lessor, the former avoids having to pay up front for the privilege of exploration, and the latter, assuming a passive role, is guaranteed participation in any eventual yield accruing from the lessee's entrepreneurial efforts, unconstrained by financial and operational responsibilities. See Martin, 27 Inst. on Oil & Gas L. & Tax'n at 194 n. 62. Inherent in the concept of lease as a bargained-for exchange is the recognition a lessor would not relinquish a valuable right arising from the leased premises without receiving something in return. Wemple, supra . In Wemple, lessor sued lessee to recover a one-eighth royalty on natural gasoline the lessee extracted from casinghead gas by the use of a separator. At the time the Lease was executed in 1909, the parties were unaware of this procedure. We determined the casinghead gas fell under the oil clause of the Lease, reasoning the parties would not have contemplated a lease where the lessee could extract a valuable substance and give nothing in return. Wemple, 145 La. at 1045, 83 So. at 237. This Court also had occasion to discuss the nature of a royalty interest in the context of ascertaining the meaning of market value of gas under a mineral lease. See Henry v. Ballard & Cordell Corp., 418 So.2d 1334, 1339 (La.1982). There, we reasoned the ambiguity in the royalty provision could not be resolved without consideration of the practical and economic realities of the oil and gas industry at the time the leases were negotiated and the obligations of the lessee to market the gas at the best possible price at the time the leases were made. Id. at 1337, 1338. Adopting the reasoning of Professor Thomas Harrell, we announced the rule that a lease arrangement is in the nature of a cooperative venture in which the lessor contributes the land and the lessee the capital and expertise necessary to develop the minerals for the mutual benefit of both parties. Id. at 1338 (citing Harrell, Developments in Non-Regulatory Oil & Gas Law, 30 Inst. on Oil & Gas L. & Tax'n 311, 334 (1979)). We also concluded the ultimate objective of the royalty provision of the lease is to fix the division between the lessor and lessee of the economic benefits anticipated from the development of the minerals. Id. We then quoted with approval Professor Harrell's contention: [A]ny determination of the market value of gas which admits the lessee's arrangements to market were prudently arrived at consistent with the lessee's obligation, but which at the same time 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. Id. at 1338 n. 10 (quoting Harrell, 30 Inst. on Oil & Gas L. & Tax'n at 336). In light of Henry, we conclude an oil and gas lease, and the royalty clause therein, is rendered meaningless where the lessee receives a higher percentage of the gross revenues generated by the leased property than contemplated by the lease. The lease represents a bargained-for exchange, with the benefits flowing directly from the leased premises to the lessee and the lessor, the latter via royalty. An economic benefit accruing from the leased land, generated solely by virtue of the lease, and which is not expressly negated, see LA.REV.STAT. ง 31:3, is to be shared between the lessor and lessee in the fractional division contemplated by the lease. See Henry, supra ; Wemple, supra .
Despite the purely contractual relationship between the lessor and lessee, the respective parties' obligations can not be determined absent reference to the covenants implied in every oil and gas lease. See Pearson & Watt, To Share or Not To Share: Royalty Obligations Arising out of Take-or-Pay or Similar Gas Contract Litigation, 42 Inst. on Oil & Gas L. & Tax'n 14-1, at ง 14.04[1] (1991). These covenants address matters not expressly covered by the lease, including protection of the lessor's interest, R. Hemingway at ง 8.1; 5 E. Kuntz, Law of Oil & Gas ง 54.2 (1991), and assist the court in ascertaining the duties incident to the relationship of lessor and lessee. Martin, 27 Inst. on Oil & Gas L. & Tax'n 177,195. At the heart of the implied obligations in Louisiana is the notion the parties consent to perform these obligations in order to effectuate the basic objectives of an oil and gas lease. L. McDougall at ง 4.1 (footnote omitted). See, e.g., Carter v. Arkansas-Louisiana Gas Co., 213 La. 1028, 36 So.2d 26 (1948). In Louisiana, the implied covenants originate not in the general principle of cooperation found in the law of contracts, see 5 Williams and Meyers, Oil and Gas Law ง 802.1 (1991), but rather as particularized expressions of Civil Code Article 2710's mandate that the lessee enjoy the thing leased as a good administrator. LA.REV.STAT. ง 31:122, comment; La.Civ.Code art. 2710. [10] The duty to act as a reasonably prudent operator, imposed on the mineral lessee by Article 122 of the Mineral Code, is thus an adaptation of the obligation of other lessees to act as good administrators. LA.REV.STAT. ง 31:122, comment. See, e.g., Waseco Chemical & Supply Co. v. Bayou State Oil Corp., 371 So.2d 305 (La.App. 2d Cir.), writ denied, 374 So.2d 656 (La.1979); Williams v. Humble Oil & Refinery Co., 290 F.Supp. 408 (E.D.La. 1968), aff'd, 432 F.2d 165 (5th Cir.1970). Article 122 of the Mineral Code provides: A mineral lessee is not under a fiduciary obligation to his lessor, but he 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. Parties may stipulate what shall constitute reasonably prudent conduct on the part of the lessee. The legislature intended to incorporate within Article 122 the existing jurisprudence on the subject, and accordingly, the mineral lessee's obligation to act as a good administrator or reasonably prudent operator is clearly specified in four situations. See LA.REV.STAT. ง 31:122, comment; McCollam, 50 Tul L.Rev. at 803. Relevant for our purposes is the implied obligation to market diligently the minerals discovered and capable of production in paying quantities in the manner of a reasonable, prudent operator. [11] LA.REV.STAT. ง 31:122, comment. See generally Shell Oil Co. v. Williams, Inc., 428 So.2d 798, 803 (La.1983); Risinger v. Arkansas-Louisiana Gas Co., 198 La. 101, 3 So.2d 289 (1941); Wall, supra ; Hutchinson v. Atlas Oil Co., 148 La. 540, 87 So. 265 (1921); Wemple, supra ; Merritt v. Southwestern Elec. Power Co., 499 So.2d 210, 214 (La. App. 2d Cir.1986); Lelong v. Richardson, 126 So.2d 819 (La.App. 2d Cir.1961); Pierce v. Goldking Properties, Inc., 396 So.2d 528 (La.App. 3d Cir.), writ denied, 400 So.2d 904 (La.1981). Encompassed within the lessee's duty to market diligently is the obligation to obtain the best price reasonably possible. See, e.g., Tyson v. Surf Oil Co., 195 La. 248, 196 So. 336 (1940). See also LA.REV.STAT. ง 31:122, comment; Martin, 27 Inst. on Oil & Gas L. & Tax'n at 191; L. McDougall at ง 4.5; Pearson & Watt, 42 Inst. on Oil & Gas L. & Tax'n at ง 14.04[1]. Regarding the fulfillment of the implied covenants, including the duty to market diligently, the lessee's conduct must conform to, and be governed by, what is expected of ordinary persons of ordinary prudence under similar circumstances and conditions, having due regard for the interest of both contracting parties. LA.REV. STAT. ง 31:122 and the comments thereto. See generally Carter, supra; Gennuso v. Magnolia Petroleum Co., 203 La. 559, 14 So.2d 445 (1943); Coyle v. North American Oil Consolidated, 201 La. 99, 9 So.2d 473 (1942); Caddo Oil & Mining Co. v. Producers' Oil Co., 134 La. 701, 64 So. 684 (1914). Our analysis is complicated by the paucity of litigation dealing with the implied obligation to market diligently, as well as the recognition that the lessee's conduct must be evaluated with due regard for the facts known at the time the Morganza Contract was executed. See 5 E. Kuntz at ง 60.3; L. McDougall at ง 4.5. Consequently, an examination of the take-or-pay provision, a clause found in nearly all gas purchase contracts, including the contract between Amoco and Columbia, is essential to resolving the issue before us. Under a take-or-pay provision, the pipeline-purchaser commits to take or, failing to take, to pay for a minimum annual contract volume of natural gas which the producer has available for delivery. Williams & Meyers, Manual of Oil & Gas Terms 1233 (1991). Where gas is paid for but not taken, the contract normally permits the purchaser to make-up the deficiency by taking an excess amount of gas (make-up gas) over a specific term and, in turn, to receive a refund or credit. See id. At the time of execution of the Morganza Contract, long-term gas contracts containing take-or-pay provisions were standard in the industry, as are take-or-pay clauses. See Henry, 418 So.2d at 1336; Kramer, Royalty Obligations Under the GunโThe Effect of Take-or-Pay Clauses on the Duty To Make Royalty Payments, 39 Inst. Oil & Gas L. & Tax'n 5-1, at ง 5.02 (1988). In the past, long-term contracts were universally insisted upon by pipeline purchasers to enable acquisition of financing for the construction of capital intensive pipeline facilities. Henry, 418 So.2d at 1336. Additionally, take-or-pay provisions allow the pipeline flexibility in the amount of gas taken, assuaging the difficulties caused by the cyclical nature of demand and the absence of an open market for natural gas. See Johnson, Natural Gas Sales Contracts, 34 Inst. on Oil & Gas L. & Tax'n 83, 111 (1983). Indeed, because gas ordinarily can not be stored upon production, the only economic means of transporting gas is via pipeline. See Merritt, supra (production is futile without distribution of the product); 1 B. Kramer & P. Martin, The Law of Pooling and Unitization ง 5.01[3] (3d ed. 1991) (A producer without a contract with a nearby pipeline is unable to sell its gas whatever the price.). The producer also benefitted from a guaranteed minimal annual cash flow and was protected from decline in demand, minimizing the likelihood it would be unable to recoup the substantial costs associated with operation and maintenance. See Medina, McKenzie, & Daniel, Take or Litigate: Enforcing the Plain Meaning of the Take-or-Pay Clause in Natural Gas Contracts, 40 Ark.L.Rev. 185, 191 n. 16 (1986) and the authority cited therein; Comment, The Lessor's Royalty and Take-or-Pay Payments and Settlements Under Gas Sales Contracts in Louisiana, 47 La. L.Rev. 589, 591 (1987). Further, because take-or-pay clauses made it more likely the purchaser would take at a more consistent level, drainage to the reservoir was minimized while the ultimate recovery, and the resultant economic benefits to the lessor and lessee, were maximized. White, The Right to Recover Royalties on Natural Gas Take-or-Pay Settlements, 41 Okla. L.Rev. 663, 680 n. 96 (citing Masten & Crocker, Efficient Adaptation in Long-Term Contracts: Take-Or-Pay Provisions for Natural Gas, 75 Am.Econ.Rev. 1083 (1985); Comment, 47 La.L.Rev. at 591. At the time the Morganza Contract was executed, a lessee who failed to execute with a pipeline purchaser a long-term gas sales contract containing a take-or-pay clause would likely be deemed to have acted imprudently. See Henry, supra ; Miller v. Nordan-Lawton Oil & Gas Corp., 403 F.2d 946, 948-49 (5th Cir.1968); 5 E. Kuntz at ง 60.3; Pearson & Watt, 42 Inst. on Oil & Gas L. & Tax'n at ง 14.04[1]. By the same token, the producer who failed to renegotiate a long term gas contract in the face of the pipeline's financial inability to perform fully under a long-term gas purchase contract, given the market conditions caused by the decline in demand and the rise in producer-pipeline litigation, would also likely be deemed to have acted imprudently. [12] See infra. Part II, ง B.