638 HighMount Expl. & Prod. LLC v. Harrison Interests, Ltd. 503 S.W.3d 557 (Tex. App.—Houston [14th Dist.] 2016, no. pet.)

Richard F. Brown

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

HighMount Expl. & Prod. LLC v. Harrison Interests, Ltd. 503 S.W.3d 557 (Tex. App.—Houston [14th Dist.] 2016, no. pet.) (Deduction of fuel gas and marketing costs from royalty) held that fuel gas was not deductible from the royalty payable under a royalty agreement. Owners sold all interest in certain real property to Producer, reserving to Owners a 5% of 8/8 perpetual non-participating royalty interest. The parties entered into a contemporaneous royalty agreement (“Agreement”) governing the administration and payment of the royalty interest. Section 4(e) of the Agreement provided that the “Owners shall receive their royalty share of the gross proceeds for gas used or utilized on or off the Subject Interests, such as gas used for fuel.” Other provisions of the Agreement provided for the deduction of various post-production costs under various circumstances. Producer deducted the fuel gas and Owners sued for underpayment of royalty.

In addressing whether royalties were owed on gas used for fuel, the court looked to Section 4(e) of the Agreement and definitions in the Agreement. The Agreement defined “gross proceeds” as “the entire economic benefit and all consideration in whatever form received by or accruing to Producer.” The court found that the term “gross proceeds” encompassed all economic benefits flowing to the Producer, except for specific exclusions listed in the Agreement and no express exclusion was applicable under the facts. Because the Agreement had no exclusion for gas used for fuel, the court held Owners were to receive their agreed upon royalty share for any gas used for fuel. The court recognized that there could be authority for industry custom and usage for the deduction of fuel gas, but custom and usage would not apply in this case. Parties to an agreement are free to expressly agree to a term that contradicts a custom or usage. “Under the plain language used in Section 4(e) the Producer must pay royalties on the gross proceeds of gas used for fuel.”

The significance of this case is the holding that the express terms of an unambiguous royalty agreement will control as to the deduction of fuel gas, even if the custom and usage in the industry may be different.