660 Burlington Resources Oil & Gas Company LP v. Texas Crude Energy, LLC, 516 S.W.3d 638 (Tex. App.—Corpus Christi 2017, pet. granted)

Tuesday, July 17th, 2018

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.

Burlington Resources Oil & Gas Company LP v. Texas Crude Energy, LLC, 516 S.W.3d 638 (Tex. App.—Corpus Christi 2017, pet. granted) (Post-production costs on overriding royalty), held that when an ORRI is payable based on the “amount realized,” then post-production costs are not deductible. Assignor conveyed to Assignee an overriding royalty assignment that provided for production to be “delivered to ASSIGNEE into the pipelines, tanks, or other receptacles with which the wells may be connected, free and clear of all development, operating, production and other costs . . . or ASSIGNOR, at ASSIGNEE’s election, shall pay to ASSIGNEE, for ASSIGNEE’s overriding royalty oil, gas or other minerals the applicable percentage of the value of the oil, gas or other minerals, as applicable, produced and saved under the leases. “Value,” as used in this Assignment, shall refer to . . . the amount realized. . . .” In other words, if production was taken in-kind the payment was free of certain costs and expenses, or if paid in cash, the royalty was based on the “amount realized.” It was undisputed that Assignee elected to receive all payments in cash. The issue was whether Assignor could deduct post-production costs.

“An ORRI, like any royalty, is generally free from production costs, such as expenses for exploration, drilling, and development. . . . However, an ORRI usually bears post-production costs such as taxes, transportation, and processing, unless the parties ‘modify this general rule by agreement’”. The issue here was whether this particular Assignment effectively modified the general rule to preclude Assignor from deducting post-production costs.

The obligation to assign the ORRI arose under a Prospect Development Agreement and Joint Operating Agreement. Assignor contended these agreements should be considered in construing the Assignment. The court held that, under the merger doctrine, the Assignment alone controlled. Under the terms of the Assignment, the “typical” ORRI was not conveyed. The ORRI is payable based on the “amount realized” and is therefore free of post-production costs. The court reasoned by analogy from oil and gas royalty clauses that payments made on “proceeds” or “amount realized” require measurement based on the amount in fact received.

The Assignment provided for payment “free and clear of all development, operating, production and other costs,” and Assignor argued that under the doctrine of ejusdem generis, the phrase “and other costs” did not include post-production costs, and therefore post-production costs were deductible. The court concluded that even if the doctrine applied, “that does not mean that the assignments may not provide elsewhere for the allocation of post-production costs.”

The significance of this case is the holding that if an ORRI payment is payable based on “amount realized” from the sale of the minerals, then the operator cannot deduct post-production costs from the ORRI payment