664 BP America Production Co. v. Red Deer Resources, LLC, 526 S.W.3d 389 (Tex. 2017)

Wednesday, August 1st, 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.

BP America Production Co. v. Red Deer Resources, LLC, 526 S.W.3d 389 (Tex. 2017), held that the critical date for determining whether a well was capable of producing in paying quantities under a shut-in royalty clause was the last day gas was sold or used. BP owned an oil and gas lease in the secondary term held by a single sporadically producing, marginal gas well. Red Deer top leased BP. June 4 was the last day gas was sold or used. On June 12, BP shut in the well. On June 13, BP sent notice to the lessors that it was invoking the shut-in royalty clause, enclosing shut-in royalty checks, and designating June 13 as the beginning of the shut-in period. The shut-in royalty clause provided:

Where gas from any well or wells capable of producing gas . . . is not sold or used during or after the primary term and this lease is not otherwise maintained in effect, lessee may pay or tender as shut-in royalty . . ., payable annually on or before the end of each twelve month period during which such gas is not sold or used and this lease is not otherwise maintained in force, and if such shut-in royalty is so paid or tendered and while lessee’s right to pay or tender same is accruing, it shall be considered that gas is being produced in paying quantities, and this lease shall remain in force during each twelve-month period for which shut-in royalty is so paid or tendered…”

Red Deer sued BP for lease termination. The question submitted to the jury was as follows:

Was the Vera Murray #11 well incapable of producing in paying quantities when it was shut-in on June 13, 2012?

The jury answered “yes” and judgment was entered terminating BP’s lease.

It was undisputed that the sixty-day cessation-of-production clause did not apply. Therefore, the shut-in royalty clause was the only savings clause that applied. The principal issue on appeal was to determine the correct date to be used when determining whether or not the gas well was capable of producing in paying quantities. This specific shut-in royalty clause required that the well be “capable of producing gas” and “[i]n many cases, [complying with the terms of the lease] means ‘it must be capable of producing gas in paying quantities at the time it is shut-in.’” BP and Red Deer disputed the proper measuring date, but both appeared to be focused on defining when the well was shut-in. The court held that the critical measuring date was not the shut-in date, but, as the plain language of the lease specified, the last date gas was “sold or used.”

That date was June 4, but the charge as submitted inquired as to June 13, the day after the day the well was shut-in. Thus, Red Deer failed to obtain a finding that the well was incapable of production in paying quantities on June 4. “Thus, Red Deer never obtained a finding that the lease failed to produce in paying quantities before constructive production took effect.” The jury’s answer to the question submitted cannot support a judgment terminating BP’s lease.

BP did not preserve error by adequately raising this issue during the charge conference, but preserved error on immateriality in post-verdict motions. The court held that the jury’s answer to the question was immaterial and “[a] party need not object to an immaterial question that should not have been submitted or cannot support a judgment to preserve error.”

The shut-in royalty clause considered in the Tracker case was almost identical to the clause considered in this case, and the court cited Tracker with approval several times. However, Tracker concluded that the measuring date was the time the well was shut-in. The court held that Tracker was distinguishable, but it appears that on this point, Tracker was virtually overruled. The definition of the phrase “capable of production in paying quantities” laid out in Tracker was adopted in Anadarko Petroleum Corp. v. Thompson in the context of the habendum clause, and thus the court in Anadarko did not need to determine the measuring date in the shut-in context.

The Anadarko case, in addressing production in paying quantities, describes the applicable test as whether the well will begin flowing, without additional equipment or repair, when it is turned “on.” In this opinion, the court adds “[t]his determination of course, must be made over a reasonable period of time under the circumstances.” This appears to be an intentional expansion of the relevant time from a mere moment to a reasonable period of time, because the court is citing to the same cases and the same pages previously cited one page earlier in the opinion for the concept that profitability to be measured over a reasonable period of time. Specifically, the court had Laddex under consideration at the same time it was deciding this case. This suggestions that the question or the accompanying instructions in this case should have made reference to a reasonable period of time for determining the profitability element of production in paying quantities.

Finally, the court considered the import of a retroactive shut-in royalty clause and appears to give it the same effect as the industry would probably expect. Once the measuring date is correctly determined, a one-year clock begins to run, and if a shut-in is tendered during that one-year window, the lease will be preserved. “A retroactive shut-in clause, like the one here, allows the producer to shut in a well up to twelve months after production has ceased, with constructive production relating back to the date the last gas was sold or used.”

The case is a contract construction case, but it is significant because it construes a very common form of shut-in royalty clause. It reviews the special issue to be submitted, and the opinion seems to suggest that production in paying quantities does not mean literally on the measuring date, but may be further qualified by a reasonable period of time under the circumstances. That is, profitability may not turn on the exact minute a well is shut-in or on the last gas actually sold, but by reference to a reasonable period of time.