Face Challenges Confidently

600 Apache Deepwater, LLC v. McDaniel Partners, Ltd. 485 S.W.3d 900 (Tex. 2016)

Monday, June 19th, 2017

Richard F. Brown

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

Apache Deepwater, LLC v. McDaniel Partners, Ltd. 485 S.W.3d 900 (Tex. 2016) (Termination of production payment at end of lease term) held that a production payment from land covered by multiple leases was reduced by the expiration of two of the leases. The parties aligned as successors in interest to Grantor and Grantee under a 1953 assignment of four oil and gas leases which reserved a production payment as follows:

[Grantor] reserves . . . as a “production payment interest,” the title to and ownership of one-sixteenth of thirty-five sixty-fourths of seven-eighths (1/16th of 35/64ths of 7/8ths, being one sixteenth of the entire interest in the production from said lands to which Assignor claims to be entitled under the terms of said respective oil and gas leases) of the total oil, gas, casinghead gas and other minerals in and under and which may be produced from the above described land . . . until the net proceeds of said reserved interest shall . . . have amounted in the aggregate to [$3,550,000.00 and 1,420,000 barrels of oil] . . . .

The issue in the case was the meaning and effect of the highlighted parenthetical. Two of the leases expired. The two expired leases covered 32/64 of the mineral estate and the two leases continuing in effect covered 3/64 of the mineral estate. Grantor contended Grantor was still entitled to 1/16 of 35/64 of 7/8. Grantee contended that Grantor’s interest was reduced, because Grantor owned only 1/16 of 3/64 of 7/8.

The case ultimately turned on the nature and operation of a production payment and the construction of this particular assignment. Apparently there was no useful precedent on production payments, and the Court generally reasoned from cases involving overriding royalties. “For purposes of this case, we agree that no meaningful differences exists between the two.” “Normally, when an oil and gas lease terminates, the overriding royalty created in an assignment of the lease is likewise extinguished.” “And, like an overriding royalty, ‘anything that terminates the lease necessarily destroys the [production] payment.’” The court held that the general rule is that when an oil and gas lease terminates a production payment created in an assignment of that lease is likewise extinguished.

Having resolved the general rule for a production payment, the Court then turned to an analysis of the assignment to determine whether the assignment showed that the parties had a different intent. “This production payment has two parts: (1) the fractional share of production that Grantee must pay, and (2) the total amount of money and production that is to be received before the interest terminates.” Part (2) was not contested; the issue was part (1).

The Court looked at what was actually being conveyed in the Assignment, which was four leasehold estates that are fee simple determinable in nature. The language in the assignment does not suggest that the production payment should come out of anything other than each of the leases. All four leases are specifically identified in the assignment, and the explanatory phrase in the production payment clause refers to “said respective oil and gas leases,” indicating the leases are treated separately. “Absent express language in the assignment to the contrary we apply the general rule that ‘when an oil and gas lease terminates, the overriding royalty [or similar production payment] created in an assignment of the lease is likewise extinguished.’” Accordingly, the correct production payment amount was 1/16 of 3/64 of 7/8, because the production payment on the terminated leases, which covered 32/64, was extinguished.

This case is significant because of the holding that production payments burdening the leasehold estate ordinarily terminate when the lease terminates. It also has implications for the assignment of production payments generally, because it is quite common for those assignments to cover large tracts with many leases, and the parties are generally not addressing the possible lease termination question.