Court Opinion

ID: 2684883
Source: CourtListenerOpinion
Date Created: 2014-07-19 05:00:28.426263+00
Date Added: 2024-06-11T13:14:36.545308
License: Public Domain

Case: 13-10619   Document: 00512700129     Page: 1   Date Filed: 07/16/2014

        IN THE UNITED STATES COURT OF APPEALS
                 FOR THE FIFTH CIRCUIT    United States Court of Appeals
                                                   Fifth Circuit

                                                                       FILED
                                                                     July 16, 2014
                                 No. 13-10619
                                                                    Lyle W. Cayce
                                                                         Clerk
CHARLES N. WARREN; ROBERT T. WARREN; ABDUL JAVEED; JOAN
JAVEED,

                                           Plaintiffs–Appellants,

v.

CHESAPEAKE EXPLORATION, L.L.C.; CHESAPEAKE OPERATING,
INCORPORATED,

                                           Defendants–Appellees.

                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:
      Charles Warren and Robert Warren brought suit against Chesapeake
Exploration, L.L.C. and Chesapeake Operating, Inc. (collectively the
Chesapeake Entities), claiming that they breached royalty provisions in oil and
gas leases by deducting post-production costs from the sales proceeds of
natural gas.   The Javeeds (Abdul and Joan Javeed) later joined the suit,
asserting similar claims. The plaintiffs appeal the district court’s dismissal of
the case for failure to state a claim. We affirm as to the Warrens’ claims, but
we modify the judgment as to the Javeeds’ claims to dismiss without prejudice.
     Case: 13-10619       Document: 00512700129          Page: 2     Date Filed: 07/16/2014

                                       No. 13-10619

                                              I
       Because we are reviewing the grant of a Rule 12(b)(6) motion to dismiss,
we accept the following factual allegations from the complaint as true. 1 This
case involves three oil and gas leases covering land in Texas. The plaintiffs,
the lessors, originally entered into the leases with FSOC Gas Co. Ltd., as the
lessee. FSOC assigned its interests in the leases to Chesapeake Exploration,
which contracted with one of its affiliates, Chesapeake Operating, to drill and
operate wells on the land covered by the leases. The wells produce natural gas
and associated fluids. The plaintiffs maintain that the Chesapeake Entities
have breached the leases by failing to comply with the lease provisions in
calculating royalties. The plaintiffs contend that the Chesapeake Entities are
not entitled to deduct certain post-production costs and expenses in calculating
the amount of royalty that is due under the leases.
       It is undisputed that in computing the plaintiffs’ royalties, Chesapeake
Exploration, the lessee, subtracted certain post-production costs.                        The
Chesapeake Entities maintain that the leases permit them to do so.
       Charles Warren and Robert Warren filed a complaint in federal district
court against the Chesapeake Entities.              They asserted breach of contract
claims and alternatively sought an equitable accounting and disgorgement of
all monies owed them. The complaint also included class action allegations on
behalf of other royalty owners that have similar leases with Chesapeake.
       Chesapeake moved to dismiss the complaint for failure to state a claim
under Rule 12(b)(6), addressing both the Warrens’ individual claims and the
class claims. Various proceedings not relevant to our disposition of the issues
on appeal occurred in the district court. The Warrens were permitted to file a

       1 See Doe ex rel. Magee v. Covington Cnty. Sch. Dist. ex rel. Keys, 675 F.3d 849, 854
(5th Cir. 2012) (citing Dorsey v. Portfolio Equities, Inc., 540 F.3d 333, 338 (5th Cir. 2008)).

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second amended complaint adding the Javeeds as plaintiffs and adding certain
exhibits to the complaint. Chesapeake was not opposed to the filing of a second
amended complaint but asked the court to rule that its original motion to
dismiss and associated briefing were not moot as to the Warrens’ re-urged
claims. The district court agreed that the original motion to dismiss was not
moot and granted that motion, dismissing with prejudice. The district court’s
order dismissed the Javeeds’ claims with prejudice as well.
      In its opinion and order dismissing the case, the court stated it would
refer to the three leases—Charles Warren’s, Robert Warren’s, and the
Javeeds’—“as a single contract” because “the relevant contractual language is
functionally equivalent in all three Lease Agreements.”                     The court
characterized all three lease agreements as involving “amount realized at the
well” royalty provisions. The court held that since the leases contained “at the
well” royalty provisions, under decisions of the Supreme Court of Texas in
Heritage Resources, Inc. v. NationsBank 2 and Judice v. Mewbourne Oil Co., 3
Chesapeake        was    authorized     to   make   post-production    deductions    in
determining the amount realized at the mouth of the well, despite the
provisions in the Warrens’ leases that the royalty would be free of certain post-
production costs.       Accordingly, the court held the plaintiffs’ claims were
precluded as a matter of law, and dismissed the entire case with prejudice.
This appeal followed.
                                             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

      2   939 S.W.2d 118 (Tex. 1996).
      3   939 S.W.2d 133 (Tex. 1996).

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most favorable to the plaintiffs. 4 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. 5
         In this diversity case, Texas law governs the interpretation of the
plaintiffs’ oil and gas leases, 6 and this court reviews a district court’s
interpretation of state law de novo. 7 Under Texas law, the question of whether
an oil and gas lease is ambiguous is one of law for the court. 8 In construing an
unambiguous lease, our task is to ascertain the parties’ intentions as expressed
in the lease. 9 We presume that the parties intended every clause to have some
effect, and we give terms their plain and ordinary meaning unless the
instrument reflects that the parties intended a different meaning. 10 Texas law
requires us to enforce an unambiguous lease as written. 11
                                                  III
         We first consider the Warrens’ leases. It is not entirely clear from the
Second Amended Complaint (the live pleading in the district court) as to whom
the gas has been sold or where the sales have occurred. The Complaint alleges
that Chesapeake Energy notified the Warrens in correspondence that the gas
produced from the leases is sold at the wellhead, after field separation, to
Chesapeake Energy Marketing, Inc.                         It is alleged that this same

         4   Doe, 675 F.3d at 854 (citing Dorsey, 540 F.3d at 338).
         5   Id. (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)).
         See H. E. Butt Grocery Co. v. Nat’l Union Fire Ins. Co., 150 F.3d 526, 529 (5th Cir.
         6

1998) (citing Erie R.R. v. Tompkins, 304 U.S. 64, 78-79 (1938)).
         7   Am. Bankers Ins. Co. v. Inman, 436 F.3d 490, 492 (5th Cir. 2006).
         8    Dynegy Midstream Servs., Ltd. P’ship v. Apache Corp., 294 S.W.3d 164, 168 (Tex.
2009).
         9   Tittizer v. Union Gas Corp., 171 S.W.3d 857, 860 (Tex. 2005).
         10   Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121 (Tex. 1996).
         11   Id.

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correspondence stated that all deductions that were made were for
transportation incurred downstream of the point of sale. The Complaint then
alleges that the Chesapeake Entities no longer rely on the argument that the
post-production costs are incurred downstream of the point of sale but instead
now contend that language in the leases addressing post-production costs is
“mere surplusage.” 12 The Chesapeake Entities assert in a footnote in their
briefing in our court that Chesapeake Exploration sold the gas at the well to
an affiliated company and that Chesapeake Exploration “paid royalty based on
the full amount it realized at the well from its affiliated purchaser.” However,
the Chesapeake Entities accept the allegations in the plaintiffs’ Complaint as
true for purposes of the motion to dismiss. Considering those allegations in
the light most favorable to the plaintiffs, the Complaint appears to allege that
sales occurred downstream from the mouth of the well and that post-
production costs incurred delivering the gas to that point of sale have been
deducted in calculating royalty payments.
       The relevant provisions in Chesapeake Exploration’s leases with Charles
Warren and Robert Warren are identical. Part of each lease is a pre-printed
lease form that contains a royalty clause in which the royalty is based on the
amount realized at the well for gas sold by Chesapeake Exploration:
       As royalty, Lessee covenants and agrees . . . (b) to pay Lessor for
       gas and casinghead gas produced from said land (1) when sold by
       Lessee, [22.5%] of the amount realized by Lessee, computed at the
       mouth of the well . . . .

Each of the Warrens’ leases also has a typed addendum attached to the pre-
printed form that addresses post-production costs and expenses:

       12See id. (holding that clauses in oil and gas leases addressing post-production costs
were “surplusage as a matter of law”).

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                                         No. 13-10619

       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. Lessor
       will, however, bear a proportionate part of all those expenses
       imposed upon Lessee by its gas sale contract to the extent incurred
       subsequent to those that are obligations of Lessee.

The addendum to the Warrens’ leases further provides:
       It is expressly agreed that the provisions of this Exhibit shall
       super[s]ede any portion of the printed form of this Lease which is
       inconsistent herewith, and all other printed provisions of this
       Lease, to which this is attached, are in all other things subrogated
       to the express and implied terms and conditions of this Addendum.

       The lessors fault the district court for its construction of the leases,
asserting that “[i]t has become too easy for courts to avoid considering
explicitly negotiated lease language and simply stamp it as ‘See Heritage,
Return to Sender,’ without opening the envelope. That is tantamount to what
the district court did here.” This criticism of the district court’s decision is
unfounded. It was not lost on the district court that if anything is clear from
the many Texas decisions dealing with royalty provisions, it is that different
royalty provisions have different meanings. The two cases on which the parties
and the district court principally rely from the Supreme Court of Texas reflect
this. In Heritage Resources, there were differing royalty provisions, though, in
that particular case, the differences did not affect the ultimate outcome. 13 In
Judice, there were three differing royalty provisions, and the outcome with

       13 Id. (“[T]he first lease is distinctly different from the others . . .” but “[t]he critical
clause in all three leases is the requirement that Heritage pay the royalty interest owners
their fractional interest of ‘the market value at the well’ of the gas produced.”).

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respect to each did depend upon the particular terms of the provision. 14 A
royalty provision’s meaning must be obtained from all of its terms.
       The district court recognized that Heritage Resources and Judice govern
this case, not because either of those decisions established immutable rules for
construing “at the well” royalty provisions but because those cases require
careful examination of the various terms and phrases the parties use. In
Heritage, some of what the parties included in their agreement had little actual
meaning. In Judice, one of the division orders conflicted internally and was
therefore ambiguous. Both of these cases expressly recognize that parties may
provide that royalty is to be based on an amount from which no post-production
costs are to be deducted, 15 but the parties have not done so in the Warrens’
leases.
       The Warrens’ leases provide in the pre-printed royalty clause that they
are entitled to 22.5% “of the amount realized by Lessee, computed at the mouth
of the well.”     As the Warrens recognize in their brief, the term “amount
realized” “require[s] measurement of the royalty based on the amount the
lessee in fact receives under its sales contract for the gas.” 16 Had the lease
provided only that the Warrens are to receive 22.5% of the amount realized by

       14 Judice v. Mewbourne Oil Co., 939 S.W.2d 133, 135-37 (Tex. 1996) (holding that
“market value at the well” lease provision allowed the lessee to allocate to the lessor its
proportionate share of the reasonable cost of post-production compression; that royalty
provisions in division orders providing “[s]ettlement for gas sold shall be based on the gross
proceeds realized at the well by you” was ambiguous because there was an inherent conflict
between “gross proceeds” and “at the well”; and that another division order that based royalty
“on the net proceeds realized at the well by you” expressly contemplates deductions for post-
production costs).
       15 Heritage, 939 S.W.2d at 131 (OWEN, J., concurring) (“There are any number of ways

the parties could have provided that the lessee was to bear all costs of marketing the gas.”).
       16 See Bowden v. Phillips Petroleum Co., 247 S.W.3d 690, 699 (Tex. 2008) (“‘Proceeds’
or ‘amount realized’ clauses require measurement of the royalty based on the amount the
lessee in fact receives under its sales contract for the gas.”) (citing Union Pac. Res. Grp. v.
Hankins, 111 S.W.3d 69, 72 (Tex. 2003)).

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Lessee, there would be little question that the Warrens would be entitled to
22.5% of the sales contract price that the lessee received, with no deduction of
post-production costs. But that is not what the lease provides. There is a
further proviso, which is that the amount realized is to be “computed at the
mouth of the well.” This quantification of what the royalty shall be applies to
all gas sold by the lessee, regardless of whether the gas is sold at the mouth of
the well, off the leased premises, or at some point in between. The phrase
“amount realized by Lessee, computed at the mouth of the well” means that
the royalty is based on net proceeds, and the physical point to be used as the
basis for calculating net proceeds is the mouth of the well. As the Supreme
Court of Texas recognized in Judice, “the phrase ‘net proceeds’ contemplates
deductions.” 17 Absent the addendum to the leases, Chesapeake Exploration
was entitled to deduct from sales proceeds the reasonable cost of post-
production costs incurred in delivering marketable gas from the mouth of the
well to the actual point of sale. We must therefore determine what effect, if
any, the addendum had.
       The addendum provides that if any portion of the pre-printed lease,
which contains a royalty clause, is “contrary” to or “inconsistent” with the
addendum, then the addendum supersedes the printed portion of the lease.
Based on the method of calculating royalty specified in the pre-printed lease
form, all royalty, regardless of where the gas sales occur, is free of post-
production     costs   such    as   compression,      dehydration,      treatment,     and
transportation. That is because “the amount realized by Lessee, computed at
the mouth of the well” necessarily excludes such costs. The addendum is not
inconsistent with the royalty clause in the pre-printed lease. It says that “all

       17Judice, 939 S.W.3d at 136 (citing Martin v. Glass, 571 F. Supp. 1406, 1411-15 (N.D.
Tex. 1983), aff’d, 736 F.2d 1524 (5th Cir. 1984)).

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royalty paid to Lessor shall be free of all costs and expenses . . . including, but
not    limited    to,   costs    of   compression,       dehydration,      treatment       and
transportation.” The addendum does not change the point at which all royalty
is computed, which is the mouth of the well. If the parties intended for the
lessor to receive 22.5% of the proceeds of sales, regardless of where the sales
occurred, they could have accomplished that end by any number of ways. 18
They could have deleted the phrase “computed at the mouth of the well.” They
could have said in the addendum that the lessor was entitled to 22.5% of the
actual proceeds of the sale, regardless of the location of the sale. They did not.
       The Warrens acknowledge that the first sentence in the addendum
addressing post-production costs is functionally equivalent to the “no
deductions” clause in Heritage and does not accomplish the result they desire.
They assert that the addition of the second sentence—“Lessor will, however,
bear a proportionate part of all those expenses imposed upon Lessee by its gas
sale contract to the extent incurred subsequent to those that are obligations of
Lessee”—makes their leases distinguishable from Heritage. More specifically,
the Warrens contend, the addition of the second sentence establishes that there
were two sets of obligations: (1) those obligations that were the sole
responsibility of Chesapeake Exploration under the first sentence (exploration,
production, and marketing of gas, including costs of compression, dehydration,
treatment, and transportation), and (2) certain shared obligations under the
second sentence (any costs incurred subsequent to Chesapeake Exploration’s
performance of (1)).         The Warrens argue that the Chesapeake Entities

       18 See Heritage, 939 S.W.2d at 131 (OWEN, J., concurring) (“If [the parties] 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. If they had intended that in addition to the
payment of market value at the well, the lessee would pay all post-production costs, they
could have said so. They did not.”) (emphasis in original).

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deducted expenses, such as costs in transporting the gas to the point of sale,
which fall within the first set of obligations, and thus were the sole
responsibility of the Chesapeake Entities and should not have been deducted
from their royalty.
      Though the language of the sentence at issue is somewhat confusing, we
cannot ascribe the meaning to the sentence that the Warrens seek.                     The
sentence provides “Lessor will, however, bear a proportionate part of all those
expenses imposed upon Lessee by its gas sales contract to the extent incurred
subsequent to those that are obligations of Lessee.” We must decipher what
expenses “incurred subsequent to those that are obligations of Lessee” means.
Under the royalty clause in the pre-printed lease, the lessee bears the expenses
of producing and selling the gas at the mouth of the well. Its obligation with
respect to royalty is to pay the amount of proceeds computed at the mouth of
the well, which means proceeds net of reasonable post-production costs
incurred beyond the mouth of the well. Nothing in the first sentence of the
addendum changes that obligation, as discussed above. To the extent that a
gas sale contract requires the lessee to bear the cost of delivering marketable
gas to a sales point other than the mouth of the well, the second sentence
expressly provides that the lessor will bear a proportionate part of all those
expenses.
      The Warrens rely on a recent Texas court of appeals decision in
Chesapeake Exploration, L.L.C. v. Hyder. 19 The royalty clause at issue in that
case is different from the Warrens’ as are the facts of Hyder. First, the Texas
court treated three affiliated Chesapeake entities interchangeably without
discussion. 20 There was no indication that any of the affiliated entities objected

      19   427 S.W.3d 472, 476 (Tex. App.—San Antonio 2014, pet. filed).
      20   See Hyder, 427 S.W.3d at 475-78.

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to the court’s analysis in this regard, apparently due to the terms of the royalty
provision. The royalty clause provided that the gas royalty was based on “the
price actually received” by Chesapeake for the gas, and the parties agreed that
post-production costs and expenses “incurred between the wellhead and
[appellant’s] point of delivery or sale of such share to a third party” could not
be deducted. 21 The parties in Hyder stipulated that Chesapeake “incurred
unaffiliated third party transportation costs of $1,750,000 allocable between
the point of delivery and the point of sale.” 22 The court held that Chesapeake
could not deduct post-production costs incurred between the well and the point
of sale in calculating the gas royalty. 23             The language of the gas royalty
provision in Hyder differs markedly from the Warrens’ royalty provision, and
Hyder does not control this case.
      We conclude that the district court did not err in dismissing the
Complaint with prejudice. We note that the parties have not argued or briefed,
and this opinion does not consider, the relationship among affiliated
Chesapeake entities or the impact, if any, that relationship might have on
matters at issue regarding the payment or calculation of royalties. We consider
only the live complaint and attachments that were before the district court.
                                                  IV
      The third lease at issue in this appeal, between Chesapeake and the
Javeeds, provides in paragraph 3 of the pre-printed lease form that: “As
royalty, Lessee covenants and agrees . . . (b) to pay Lessor for gas and
casinghead gas produced from said land (1) when sold by Lessee, 20% of the

      21   Id. at 476 (alteration in original).
      22   Id.
      23   Id. at 477-78.

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amount realized by Lessee, computed at the mouth of the well . . . .” An Exhibit
attached to the lease provides:
      Notwithstanding any of the provisions contained in the oil and gas
      lease to which this exhibit is attached, the following provisions
      shall apply:

      13. The royalties to be paid by lessee are: . . . (b) on gas, including
      casinghead gas or other gaseous substances produced from said
      land or sold or used off the premises or for the extraction of
      gasoline or other products therefrom, the market value at the point
      of sale of 20% of the gas so sold or used. However, in no event shall
      the royalty paid to Lessor be less than the Lessor’s royalty share
      of the actual amount realized by the lessee from the sale of oil
      and/or gas. 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.
      Lessor will, however, bear a proportionate part of all those
      expenses imposed upon Lessee by its gas sale contract to the extent
      incurred subsequent to those that are obligations of Lessee.

      The Javeeds and the Warrens filed a joint initial brief in our court. That
briefing did not fully quote the provisions of the Javeeds’ lease. It made no
mention of the provision that royalty to be paid is “the market value at the
point of sale of 20% of the gas so sold or used.” The Javeeds’ royalty provisions
differ substantially from the Warrens’ royalty provisions. Nevertheless, the
briefing is based on the Warrens’ royalty provisions. The arguments in the
initial briefing do not address the Javeeds’ differing provisions. The district
court treated the Warrens’ leases and the Javeeds’ lease as “functionally
equivalent,” and the plaintiffs’ opening brief before this court did the same. It
was not until the plaintiffs’ reply brief in this court that the Javeeds asserted
that their lease was meaningfully different than the Warrens’ leases. The
reply brief also argued, for the first time on appeal, that Chesapeake did not

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move to dismiss the Javeeds’ claims at all. Arguments raised by appellants for
the first time in reply briefs are waived. 24 Accordingly, because the only
contention raised by the Javeeds in the opening brief are the same contentions
raised by the Warrens, we do not consider the argument the Javeeds presented
in the reply brief.
      We conclude, however, that the Javeeds’ claim should not have been
dismissed with prejudice. It is not apparent from the face of the complaint or
its attachments that they could not conceivably state a cause of action.
                                   *        *         *

      The judgment of the district court is AFFIRMED as to the Warrens’
claims. The judgment of the district court is MODIFIED as to the Javeeds’
claims to a dismissal without prejudice.

      24 Valle v. City of Hous., 613 F.3d 536, 544 n.5 (5th Cir. 2010) (holding that the
appellants waived an argument by failing to raise it in their opening brief).

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