Court Opinion

ID: 9918469
Source: CourtListenerOpinion
Date Created: 2024-01-13 01:00:49.403371+00
Date Added: 2024-06-11T08:01:40.011625
License: Public Domain

Case: 22-20226        Document: 00517032056             Page: 1      Date Filed: 01/12/2024

               United States Court of Appeals
                    for the Fifth Circuit                                  United States Court of Appeals
                                                                                    Fifth Circuit

                                     ____________                                 FILED
                                                                           January 12, 2024
                                      No. 22-20226
                                                                             Lyle W. Cayce
                                     ____________                                 Clerk

   Anne Carl, as Co-Trustee of the CARL/WHITE TRUST, on behalf
   of itself and a class of similarly situated persons; Anderson White, as Co-
   Trustee of the CARL/WHITE TRUST, on behalf of itself and a class of
   similarly situated persons,

                                                                  Plaintiffs—Appellants,

                                            versus

   Hilcorp Energy Company,

                                               Defendant—Appellee.
                     ______________________________

                     Appeal from the United States District Court
                         for the Southern District of Texas
                              USDC No. 4:21-CV-2133
                     ______________________________

   Before Dennis, Elrod, and Ho, Circuit Judges.
   Per Curiam:1
           In this mineral royalty dispute, the lessors appeal the district court’s
   dismissal of their claim that the lessee must pay royalties on gas used off-lease
   for post-production services like transport and processing. Because we

           _____________________
           1
            Judge Dennis concurs only in the decision to certify the questions to the Supreme
   Court of Texas.
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                                      No. 22-20226

   cannot confidently make an Erie guess on this issue that is likely to recur, we
   CERTIFY two questions to the Supreme Court of Texas.
                                            I
          Anne Carl and Anderson White, as trustees of the plaintiff
   Carl/White Trust, and defendant Hilcorp Energy Company are successors
   in interest to a mineral lease that governs at least two wells in Brazoria
   County, Texas. Under this lease, Hilcorp must pay royalties to the Trust
   “on gas . . . produced from said land and sold or used off the premises . . . the
   market value at the well of one-eighth of the gas so sold or used.” Hilcorp
   also “shall have free use of . . . gas . . . for all operations hereunder.”
          The Trust filed a class action complaint on behalf of royalty owners
   with similar leases alleging that Hilcorp failed to pay royalties on gas used in
   off-lease post-extraction processing services, such as compression and
   dehydration, necessary to make the gas saleable, commonly referred to as
   “post-production costs.” See Burlington Res. Oil & Gas Co. LP v. Texas Crude
   Energy, LLC, 573 S.W.3d 198, 203 (Tex. 2019). The Trust’s complaint
   asserted that two provisions of the mineral lease entitle it to royalties on gas
   used off-lease for post-production costs.         The off-lease clause requires
   Hilcorp to pay royalties for gas “sold or used off the premises,” and the free-
   use clause provides for the free use of gas, but only when used for
   “operations” on the lease premises. The Trust asserted in its complaint that
   the off-lease clause expressly requires Hilcorp to pay royalties on gas “used
   off the premises” and the free use clause, by providing for free use of gas on-
   lease, impliedly excludes the possibility of free use of gas off-lease.
          Hilcorp moved to dismiss the Trust’s complaint for failure to state a
   claim, arguing that the lease calculates royalties based on the market value at
   the well, a value which necessarily excludes any gas used in post-production
   costs. The district court agreed, observing that the market value at the well

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                                     No. 22-20226

   clause was the “critical clause in interpreting the lease agreement at issue.”
   Applying the “workback method” recognized under Texas law, the district
   court found that post-production costs would be deducted from the Trust’s
   royalty calculation. Because the complaint only alleged unpaid royalties on
   these deductions, the district court reasoned that the Trust sought royalties
   to which it was not entitled under the lease. The court granted the motion to
   dismiss. It did so without prejudice, however, and granted the Trust leave to
   amend its allegations of off-lease use for non-post-production purposes. The
   Trust filed a Second Amended Complaint with the new assertion that: “Gas
   that is not sold, but is used off the lease, can be and is used for many purposes
   and locations and never reaches a point of sale.” The district court dismissed
   this complaint as well, determining that the Trust’s vague amendment failed
   to allege with specificity any off-lease gas used in non-post-production
   activities, and that the complaint otherwise failed for the same reasons
   provided in the court’s earlier order. The Trust’s complaint was dismissed
   with prejudice. The Trust timely appealed.
                                          II
          “We review de novo a district court’s dismissal under Rule 12(b)(6),
   accepting all well-pleaded facts as true and viewing those facts in the light
   most favorable to the plaintiffs. To survive a Rule 12(b)(6) motion to dismiss,
   plaintiffs must plead enough facts to state a claim for relief that is plausible
   on its face.” Warren v. Chesapeake Expl., L.L.C., 759 F.3d 413, 415 (5th Cir.
   2014) (citations omitted). In this Class Action Fairness Act diversity case,
   see 28 U.S.C. § 1332(d), “Texas law governs the interpretation of the
   plaintiffs’ oil and gas leases, and this court reviews a district court’s
   interpretation of state law de novo.” Warren, 759 F.3d at 415 (citations
   omitted).

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                                          III
          We begin with some background. Gas production is the process of
   bringing raw gas to the surface. BlueStone Nat. Res. II, LLC v. Randle, 620
   S.W.3d 380, 386 (Tex. 2021) (citing 8 Williams & Meyers Oil and
   Gas Law, Manual of Oil & Gas Terms, at 833 (2020)). “A royalty
   payment, which represents a lessor’s fractional share of production from a
   lease, may be calculated at the wellhead or at any downstream point,
   depending on the lease terms. Gas royalties are generally free of the expenses
   incurred to extract raw gas from the land (production costs) but not expenses
   incurred to prepare raw gas for downstream sale (postproduction costs).
   Because mineral leases are contracts, these general rules may be modified as
   the parties see fit.” Id. at 387 (citations omitted).
          Royalty clauses typically have three components: “(i) the royalty
   fraction—e.g., 1/8th, 25%, 1/5th; (ii) the yardstick—e.g., market value,
   proceeds, price; and (iii) the location for measuring the yardstick—e.g., at
   the well, at the point of sale.” BlueStone Nat. Res. II, LLC v. Randle, 601
   S.W.3d 848, 856 (Tex. App.—Forth Worth 2019) (citing Byron C. Keeling,
   In the New Era of Oil & Gas Royalty Accounting: Drafting a Royalty Clause That
   Actually Says What the Parties Intend It to Mean, 69 Baylor L. Rev. 516,
   520 (2017)), aff’d in part, rev’d in part on other grounds, 620 S.W.3d 380 (Tex.
   2021). The royalty clause in the Trust’s lease provides the Trust with a
   royalty of 1/8 of the market value at the well of all gas sold or used off the
   premises. Following the taxonomy above, its components are (i) 1/8 (ii) of
   the market value (iii) measured at the well.
          The market value of gas is typically lower at the wellhead than it is at
   a downstream point of sale. This is because “[a]n arm’s length purchaser
   typically will pay more for oil and gas that the lessee has already transported
   to a downstream market and compressed, processed, treated, and otherwise

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   made ready for a downstream sale.” Keeling, supra, at 525; see also Devon
   Energy Prod. Co., L.P. v. Sheppard, 668 S.W.3d 332, 336 (Tex. 2023) (“These
   investments generally make production more valuable.”).               Thus, the
   standard interpretation of a market value at the well provision in a mineral
   lease is that it “means value at the well, net of any value added . . . after [the
   gas] leaves the wellhead.” Judice v. Mewbourne Oil Co., 939 S.W.2d 133, 135
   (Tex. 1996); see also Chesapeake Expl., L.L.C. v. Hyder, 483 S.W.3d 870, 873
   (Tex. 2016) (“The market value at the well should equal the commercial
   market value less the processing and transporting expenses that must be paid
   before the gas reaches the commercial market.”).
          In a royalty dispute, it is the royalty owner’s burden to prove the
   market value at the well. Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118,
   122 (Tex. 1996). In Texas there are two accepted methods to determining
   market value at the well. Id. The preferred is the “comparable sales”
   method, which uses “actual sales that are ‘comparable in time, quality,
   quantity, and availability of marketing outlets.’” Randle, 620 S.W.3d at 388
   (quoting Heritage Res., 939 S.W2d at 122). The second is the “workback
   method,” which is used when comparable sales data is unavailable. Id. at
   388–89. This method estimates the wellhead value by deducting post-
   production costs from the proceeds of downstream sale. Id. “Although
   parties to an agreement may define post-production costs any way they
   choose,   the    term   generally    applies     to   processing,   compression,
   transportation, and other costs expended to prepare raw oil or gas for sale at
   a downstream location.” Burlington Res., 573 S.W.3d at 203. Consistent
   with the notion that a mineral’s value at the wellhead is less than its value
   after being transported, processed, and prepared for market, the workback
   method allows the lessee to subtract these value-enhancing, post-production
   costs to estimate the worth of the mineral before those services were
   rendered. Keeling, supra, at 532. “[W]hile the comparable sales method is

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   the preferred way of calculating the wellhead value of oil and gas production,
   the vast majority of lessees do not use—and have never used—the
   comparable sales method to calculate their royalty payments. This is true, as
   a practical matter, because wellhead sales of oil and gas have become
   increasingly less common since the early 1990s.” Id. at 531.
          Where comparable sales allegations are not pleaded or proven, Texas
   courts have consistently applied the workback method to calculate royalties
   based on market value at the well. See Heritage Resources, 939 S.W.2d at 123
   (“Because there is no evidence to support the comparable sales method of
   computing market value at the well, we use the [workback] method.”);
   Occidental Permian Ltd. v. French, 391 S.W.3d 215, 222 (Tex. App.—Eastland
   2012) (“Having concluded that no evidence exists to support the trial court’s
   [comparable sales] determination of market value at the well, we next must
   examine whether that value is supported by evidence under the [workback]
   method.”); see also Randle, 620 S.W.3d at 388 (“When comparable sales data
   is unavailable, an alternative methodology for determining ‘market value’ at
   a specified valuation point is the . . . ‘workback’ method.”); Potts v.
   Chesapeake Expl., L.L.C., 760 F.3d 470, 475 (5th Cir. 2014) (“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.”). Thus, the workback method, while not
   preferred when the comparable sales method is available, is nonetheless a
   perfectly adequate “proxy” for the lease term “market value at the well”
   when the comparable sales method is unavailable. Randle, 620 S.W.3d at 389.
                                        IV
          The parties dispute whether, under the workback method, the lessee
   must pay royalties on gas used off-lease as part of the post-production

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   process. The off-lease clause requires Hilcorp to pay royalties for gas “sold
   or used off the premises,” and the free-use clause provides for the free use of
   gas, but only when used for “operations” on the lease premises. The district
   court held that these provisions did not preclude lessees from deducting gas
   used as fuel during post-production or as in-kind payment for post-
   production services from the amount of gas on which royalties were owed.
          The Trust argues that, under the Supreme Court of Texas’s recent
   decision in Randle, the lease’s market value at the well provision does not
   limit or affect the off-lease and free-use clauses, which clearly entitle it to
   royalties on gas used off-lease. The Trust further argues that even if such gas
   can be deducted, the deduction can only be applied to the value per unit of
   gas. It cannot reduce the number of units of gas on which royalties must be
   paid. Hilcorp contends that, as the district court held, Randle is inapplicable
   because it concerned a gross-value-received lease, rather than a value-at-the-
   well lease. While Randle does concern a different type of lease, the section of
   that opinion addressing the free-use clause can be read to address free-use
   clauses generally. This raises the question of whether the free-use clause
   here, when read in conjunction with the rest of the lease, permits deduction
   of gas used off-lease for post-production purposes. The uncertainty about
   Randle’s effect raises the question of whether the appropriate course is to
   certify the issue for resolution by the state court of last resort. It also raises
   the question of how a potential deduction should be applied.
          The Texas Rules of Appellate Procedure authorize the Supreme
   Court of Texas to “answer questions of law certified to it by any federal ap-
   pellate court if the certifying court is presented with determinative questions
   of Texas law having no controlling Supreme Court precedent.” Tex. R. App.
   P. 58.1. The issues presented here satisfy that condition. The issues pre-
   sented also satisfy the three factors we use in deciding whether to certify:

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          1) [T]he closeness of the question and the existence of suffi-
             cient sources of state law;
          2) [T]he degree to which considerations of comity are relevant
             in light of the particular issue and case to be decided; and
          3) [P]ractical limitations on the certification process: signifi-
             cant delay and possible inability to frame the issue so as to
             produce a helpful response on the part of the state court.

          In re Gabriel Inv. Grp., 24 F.4th 503, 507 (5th Cir. 2022). The
   circumstances here strongly support certification. “[A]ny Erie guess would
   involve more divining than discerning.” McMillan v. Amazon.com, Inc., 983
   F.3d 194, 202 (5th Cir. 2020). Randle is a recent case, and we are not aware
   of any opportunity that Texas courts have had to address whether its free-use
   analysis applies to value-at-the-well leases. The parties cite several cases in
   support of their respective positions, but the Texas cases precede Randle and
   the federal cases, while careful and thoughtful, are Erie guesses about what
   the Supreme Court of Texas would do. Accordingly, the cited cases do not
   provide sufficient guidance as to Texas law on these issues. Comity interests
   also favor certification, as the interpretation of mineral leases are an
   important and significant part of Texas state law. Finally, we are not aware
   of any practical impediments to certification.
                                  *        *         *
          Accordingly, we CERTIFY the following determinative questions of
   law to the Supreme Court of Texas:
          1) After Randle, can a market-value-at-the well lease containing an off-
   lease-use-of-gas clause and free-on-lease-use clause be interpreted to allow
   for the deduction of gas used off lease in the post-production process?
          2) If such gas can be deducted, does the deduction influence the value
   per unit of gas, the units of gas on which royalties must be paid, or both?

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         We disclaim any intention or desire that the Supreme Court of Texas
   confine its reply to the precise form or scope of the questions certified. We
   will resolve this case in accordance with any opinion provided on these
   questions by the Supreme Court of Texas. The Clerk of this Court is directed
   to transmit this certification and request to the Supreme Court of Texas in
   conformity with the usual practice.
         QUESTIONS CERTIFIED.

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