Face Challenges Confidently

078 Heritage Resources Inc., v. Nations Bank

Thursday, September 3rd, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
Heritage Resources, Inc., v. Nationsbank – S.W. 2d –, 1996 WL 200362 (April 25, 1996, motion for rehearing pending) is a very recent Texas Supreme Court opinion in a division order case. We reported on the Court of Appeals opinion in this case in the March 1996 Pipeline and suggested then that the opinion was so important and the reasoning of the Court of Appeals was so weak that we might see a significant reversal in the Supreme Court. The central issue in the case was whether the lessee (Heritage) could deduct transportation costs from the royalty. The royalty clauses in the leases at issue expressly provided that the royalty owners would receive as royalty a fractional part of the “market value at the well” and went on to recite that “there shall be no deductions from the value of the Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas.” Heritage deducted a prorata portion of the transportation charges charged by the gas transporter from the lessor’s royalty.
Heritage asserted a defense based primarily on its division orders, which expressly provided that the royalty payments would be subject to transportation costs. There was also an express provision in the division order which limited liability for wrongful payment to a cause of action against the overpaid party. After apparently conceding that the division orders ordinarily would be a defense until revoked, the Court of Appeals held that division orders are not binding on a royalty owners when the lessee benefits from an error in the orders and it thereby unjustly enriched.
The El Paso Court concluded that there was evidence upon which the trial court could properly conclude that Heritage profited from the error in the division orders, and therefore the royalty owners were not bound by the division orders. Heritage and the transporter of the gas were under common ownership, but the transporter did have a minority interest owned by an unrelated party. There is nothing else in the opinion explaining how the lessee Heritage profited, except the observation that the sole shareholder of Heritage also happened to be the majority shareholder of the gas transporter. Profit to the transporter would appear to be unrelated to the lessee Heritage, unless the corporate distinctions are ignored.
The Supreme Court reversed and rendered judgment that the lessor Nationsbank take nothing, because market value at the well means net of post-production costs. The Court found that “market value at the well” has a commonly accepted meaning in the oil and gas industry. It means the price a willing buyer will pay a willing seller at the well, and it is determined by comparable sales. In the absence of comparable sales, it is determined by subtracting reasonable post-production marketing costs from the market value at the point of sale. Therefore, the Court concluded that, under this particular lease royalty clause, market value at the well (comparable sales) could not be reduced by post production costs, which simply restates the exiting Texas law. However, when there are no comparable sales, reasonable post-production marketing costs are deducted from the market value at the point of sale. This apparently includes at least taxes, treating and transportation.
Because the deductions were proper and the royalty owners received the proper royalty, the Supreme Court did not have to deal with any division order issue. Nevertheless, the Court went on to specifically disapprove of the Court of Appeal’s language about the liability of an operator who underpays royalty interest owners. Gavenda v. Strata Energy, Inc., 705 S.W.2d 690 (Tex. 1986) established the principle that division orders are binding until revoked, with the exception that to the extent the lessee retains an unjust benefit, the division order is not binding. In other words, the lessee who overpays himself at the expense of the royalty owner signing the division order cannot hide behind the division order. If the wrongful payment has gone to someone else, the lessee can hide behind the division order. Any other result would defeat the utility of the division order in expediting payments and would further delay the orderly resolution of ordinary title issues. This part of the decision should be very helpful in reducing the confusion about the effectiveness of division orders. To recover any payments made under a division order prior to revocation, the remedy must be pursued against the party who ended up with the money, and it can be pursued against that party only to the extent of the money that party received. It is a bright line, a distinctive line, and fits within the well-established legal doctrine of unjust enrichment.
In clarifying the effect of division orders, the decision is a good one. It is hard to see how any party could complain. Don’t sign a division order and accept benefits, unless you are sure of your own interest. Once payments are made, you cannot recover for an underpayment against anyone except the party receiving the unjust enrichment. As to “market value” and “post production costs,” this case will be dissected by lawyers for years. In an era of gathering system spin-offs and increasing gathering costs, it will be an area of litigation for some time. The opinion clearly does the industry a service by adopting in the highest court of the State a principle that everyone thought was resolved: unless otherwise agreed, market value at the well means net of post production costs. Whether this particular lease royalty clause did or did not amount to “otherwise agreed” is a closer question, but the underlying principles are sound. This is exciting stuff, but then maybe only lawyers get excited about this stuff.