Articles Posted in Oil and Gas Law

A federal appellate court decision demonstrates some lessons for Texas mineral owners. That decision was issued by the Fifth Circuit Court of Appeals in the case of Breton Energy, L.L.C., et al. v. Mariner Energy Resources, Inc., et al. The Plaintiffs in this case own and operate an off-shore lease in the Gulf of Mexico that includes an area known as the K-1 sands. The Defendants own and operate an adjacent off-shore lease that covers an area known as the K-2 sands. The Plaintiffs claimed that the Defendants engaged in “unlawful drainage” from the Plaintiffs’ lease in violation of federal and state law.

The Facts:

Breton Energy LLC and Conn Energy Inc. sued International Paper Co. and its successors in interest, consisting of eleven oil companies including Apache Corporation, Chevron and I.P. Petroleum Co. The Plaintiffs claimed specifically that IP Petroleum perforated and drained an oil reservoir under the Plaintiffs’ lease on the Outer Continental Shelf in the K-1 sands. The Plaintiffs also claimed that IP co-mingled resources from this reservoir with hydrocarbons from a nearby reservoir, making it impossible for the Plaintiffs to produce oil and gas from its own wells.The evidence showed that I P Petroleum, even though it had been ordered by the federal Minerals Mining Service not to complete wells in both the K-1 and K-2 sands, did in fact complete wells in both areas. There was also evidence that I P Petroleum’s production exceeded their estimate by almost 30%, which would make sense if they were producing from someone else’s reservoir as well as their own.

The District Court dismissed the Plaintiffs’ claims, and they appealed to the Fifth Circuit.

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The Railroad Commission of Texas (the RRC) is planning to amend their permit rule for oil and gas pipelines. The section to be amended, section 3.70, involves the pipeline permit procedure. The RRC invited comments on the changes until August 25, 2014. The issue has become a hot topic, especially since Texas already has substantial case law on what constitutes a common carrier.

Current Texas Law

Texas law requires that to be considered a common carrier a pipeline must serve a “public purpose” in carrying products for third parties for compensation, as discussed in the Denbury Green opinion by the Supreme Court of Texas. (You can access my previous blog post about this case here). In the Denbury Green case, the Supreme Court said that when a landowner challenges a pipeline’s claim of common carrier status, the burden is on the pipeline company to prove it meets the definition of a common carrier.

The Texas Railroad Commission approved a substantial amendment to its oil and gas pipeline permit rule on December 2, 2014, and the amendment has major significance for Texas landowners and Texas mineral owners. The rule is Texas Railroad Commission Rule 3.70, and the amended rule goes into effect on March 1, 2015.

The Railroad Commission received a substantial amount of written comment from individuals, oil companies and trade organizations. Comment and testimony was also received at the public hearing on the proposed amendment held in Austin, Texas on September 22, 2014. The amended Rule 3.70 and the discussion of public comments by the Commission’s General Counsel can be accessed here.

The amended Rule 3.70 provides that each operator of a pipeline or gathering system (other than production lines or flow lines that are general confined to the leased premises) must obtain a permit from the Commission and renew the permit annually. The permit application must now include the following:

The United States Fifth Circuit Court of Appeals recently published their decision in  Holt Texas, Limited and Transamerican Underground, Limited v. Stephen J. Zayler, a case which concerned a bankrupt oil and gas company. Holt Texas, Ltd. (“Holt”) and Transamerica Underground Limited (“TAUG”) who were subcontractors of the now bankrupt T.S.C. Seiber (“Seiber”) appealed the District Court’s judgment which in turn affirmed a Bankruptcy Court order. The District Court held that funds of an interpleader action filed by Encana Corporation (“EnCana”) were not property of Encana but property of the bankrupt company Seiber. On appeal, Holt and TAUG challenged the District and Bankruptcy Courts’ conclusions that first, the Texas Construction Trust Funds Act (“CTFA”) did not apply to these funds, and secondly, that Appellants did not have valid, perfected mineral liens on these funds under Chapter 56 of the Texas Property Code. The Fifth Circuit Court of Appeals vacated the District Court’s judgment and remand for further proceedings.

Background: In 2008 Encana engaged Seiber to build a natural gas pipeline in Robertson County, Texas. Holt and TAUG were the subcontractors; Holt provided heavy machinery and TAUG installed over two thousand feet of pipe. The agreement between Encana’s and Seiber specified that if a subcontractor was not paid by Seiber, Encana would be able to withhold all remaining sums and make no further payment to Seiber. In August 2009 TAUG notified Encana that it had not been paid recently, and would seek payment of the $96,3000 that TAUG claimed it was owed. In September 2009 Encana filed an interpleader in federal district court, paid $345,000.00 into that court’s registry and sought a declaration shielding it from any further liability for the unpaid amounts owed by Seiber. In October 2009 Seiber filed a voluntary petition for bankruptcy relief under Chapter 11 of the Bankruptcy Code, which was quickly converted to a Chapter 7 petition. TAUG then filed an Affidavit Claiming Mineral Lien against Encana’s property in November 2009. Holt filed its Affidavit Claiming Mineral Lien in March 2010. Encana was discharged from the interpleader in April 2012 and a discharge order was entered. The remaining parties filed competing motions for summary judgment: Holt and TAUG argued that two sets of Texas statutes (the Construction Trust Funds Act and the Texas mechanics lien statutes) that are intended to protect subcontractors require that the interpleader funds be awarded to them. The Bankruptcy Court held that neither law applied and that the interpleader funds were part of the bankruptcy estate of Seiber. Holt and TAUG appealed to the District Court, which affirmed the ruling of the Bankruptcy Court. Holt and TAUG then appealed to the Fifth Circuit.

Arguments: The Fifth Circuit discussed whether the interpled funds were property of the bankruptcy estate of Seiber or not. The opinion discussed that this question turns on who had legal possession of the funds after deposit into the registry of the court but before any action was taken by the court as to those funds. Chapter 56 of the Texas Property Code provides mineral subcontractors with a statutory lien “to secure payment for labor or services related to the mineral activities.” Tex. Prop. Code. §56.002. Chapter 162 of the Texas Property Code states that “Construction payments are trust funds under this chapter of the payments are made to a contractor or subcontractor … under a construction contract for the improvement of specific real property in this state.” Tex. Prop. Code §162.001(a). Section 162 protects subcontractors without requiring notice or other action by the subcontractor, such as sending a notice or filing an affidavit.

Recently the Fifth U.S. Court of Appeals issued an interesting decision in the case of Warren et al. v. Chesapeake. This very important case for Texas mineral owners is based on a lawsuit against Chesapeake Exploration for what the Plaintiffs claimed was the wrongful deduction of post-production costs from the Plaintiffs’ gas royalty payments.

The Facts

The Warren case involves three oil and gas leases in Texas. Charles and Robert Warren entered into leases with FSOC Gas Co. Ltd. Those leases were then assigned to Chesapeake, who used an affiliate, Chesapeake Operating, to drill and operate the wells. Chesapeake deducted post-production costs from the royalty payments to the Warrens as well as from royalties to Abdul and Joan Javeed who joined the case as plaintiffs later. Chesapeake claimed that the leases authorized the deductions. The Plaintiffs asserted that Chesapeake breached the leases because the deductions did not comply with the lease provisions on calculating royalties. The complaint also included class action allegations on behalf of other royalty owners with similar leases with Chesapeake Exploration.

As readers of this blog know, we have been following the case of Marcia Fuller French, et al. v. Occidental Permian Ltd., which is an important Texas case involving gas royalties. You can read our previous blog post here. The case was heard by the Supreme Court of Texas on February 5, 2014 and the The Texas Supreme Court has issued its decision.

As you may recall, Martha Fuller French and the other Plaintiffs were royalty owners and lessors on two oil and gas leases in Scurry County and Kent County, Texas. One lease is referred to in the decision as the “Fuller Lease”, which was executed in 1948, and the other lease is referred to as the “Cogdell Lease”, which was leased 1949.

In 2001, Occidental Permian began injecting wells on these leases with carbon dioxide to boost oil production. As a result, the natural gas produced from these leases contained about 85% carbon dioxide. Occidental then treated the gas to remove the carbon dioxide and sold the remaining gas, sending the carbon dioxide back to be reused at the well. Occidental paid Ms. French and the others royalties on the gas after it was treated and then deducted treatment costs from the royalties.

An interesting case was in the news recently and oil and gas attorneys have been following it with interest. The case is Lisa Parr, et al. vs. Aruba Petroleum, Inc., et al.; County Court at Law No. 5, Dallas County, Texas; Cause Number: CC-11-01650.

The Background

The Parrs have a 40 acre ranch in Decatur, Texas which is about 60 miles northwest of Dallas, Texas. The ranch sits on the Barnett Shale. Robert and Lisa Parr and their 11 year old daughter Emma alleged that they started having health problems in 2008, including migraine headaches, dizziness and nausea. By 2009, Lisa Parr said: “(m)y central nervous system was messed up. I couldn’t hear, and my vision was messed up. My entire body would shake inside. I was vomiting white foam in the mornings.” She claimed that her husband and daughter had nosebleeds, vision problems, nausea, rashes and blood pressure issues.

As a Texas oil and gas attorney, I often explain to clients how important it is to be smart and review oil and gas leases, contracts and other legal documents before signing anything. So many people sign documents without reading or understanding them first and come to me after the fact, when it is much harder and often impossible to do anything about it–money and peace of mind have already been lost. I recently read a case, Ayala and Chesapeake Exploration LLC v. Soto, that exemplifies exactly this situation.

Natividad Soto is a 75 year old man and land and mineral owner in LaSalle County, Texas. He cannot read or write in English. He was approached by Henry Gilbert Ayala, a prison guard and mayor pro tem of Cotulla, Texas who was an acquaintance of Soto’s niece. Mr. Ayala allegedly pressured Mr. Soto into signing what Mr. Soto thought was an oil and gas lease. Mr. Soto actually signed a durable power of attorney to Ayala, giving Ayala authority to sign oil and gas leases and certain other documents for Mr. Soto.. Mr. Soto claims no one explained what the document was and he did not seek assistance from anyone before he signed. Mr. Ayala filed the power of attorney in the county deed records and then signed two mineral leases with Chesapeake Exploration.

A few days later, Mr. Soto consulted an attorney. The attorney prepared and filed revocations of the power of attorney with the county clerk’s office. A few weeks later, Chesapeake sent a check of almost $239,000 as lease bonus to Ayala. Ayala kept the money and claimed that Soto agreed that Ayala could keep the bonus funds as his fee.

The Supreme Court of Texas will be considering an interesting case about oil and gas royalties for a Texas mineral owner. The case is Charles G. Hooks III et al. v. Samson Lone Star L.P.

The case arises from a dispute over oil and gas leases in Jefferson County and Hardin County, Texas. The mineral and land owner is Charles G. Hooks, III, who is also an oil and gas attorney. The Jefferson County lease provided that the lessee, Samson Lone Star LLC pay compensation to Mr. Hooks if drilling occurred within 1,320 feet of his property line. Samson drilled a directional well that bottomed out within that distance, but Samson never compensated Mr. Hooks as the lease required. With the two Hardin County leases, Mr. Hooks gave Samson permission to pool his mineral interests, but Mr. Hooks contended that Samson did not pay him for all production within the pool. Mr. Hooks also claimed that Samson was required to pay both royalties on the sale of oil and gas and on the same oil and gas as it existed in the reservoir, so called “formation production”.

In the trial court, Mr. Hooks was awarded more than $21 million on these claims. The case was appealed to the Houston Court of Appeals, which reversed the judgment of the trial court in a majority decision written by Justice Evelyn V. Keyes in 2012. The Houston Court of Appeals determined that, as to the Jefferson County lease, Mr. Hooks’ claim was barred by the statute of limitations and was based on an incorrect interpretation of his oil and gas lease. The Court noted that surveys on file for this well at the Texas Railroad Commission in 2000 and publicly accessible put Hooks on notice of the location of the bottom of Samson’s directional well, and as an oil and gas lawyer, Hooks should have been aware of his claim if he reviewed both those surveys. Unfortunately, Hooks did not file the lawsuit against Samson until after the four year statute of limitations that applied to his claim had expired.

A recent case decided by the U.S. Sixth Circuit Court of Appeals holds a cautionary tale for Texas investors or any one who may want to invest in oil and gas. The case is United States v. Smith decided on April 15, 2014.

This case involved the Smith brothers, Michael and Christopher, who operated a company called Target Oil. Target conducted speculative oil drilling in several states, including Texas, but also in Kentucky, West Virginia, and Tennessee. The Smiths told potential investors that certain wells were sure-fire investments, but these wells often produced no oil at all. In fact, some of the wells had not even been drilled. Investigators discovered that from 2003 to 2008, Target Oil received approximately $15.8 million from investors, but only distributed royalties amounting to $460,000. Their operation was a classic Ponzi scheme. That means that the Smith brothers paid new investors from the investment funds of previous investors, rather than from the production proceeds from the wells they were supposed to be drilling. As in all Ponzis, for the first few months the investor thinks they’ve made a good investment. At some point, as in all Ponzis, the fraudsters run out of new investors to scam and the returns to investors stop. The newer investors get nothing at all. These kinds of schemes seem to come out of the woodwork when the price of oil approaches $100 per barrel.

Michael and Christopher Smith were arrested and charged with conspiring with others to defraud investors of millions of dollars. In the trial court, Michael Smith was convicted of conspiracy to commit mail fraud and of 11 substantive counts of mail fraud. He was sentenced to 120 months in prison and ordered to pay $5,506,917 in restitution. Christopher Smith was convicted by the same jury on seven counts of mail fraud. He was sentenced to 60 months in prison and ordered to pay $1,652,075 in restitution. The Sixth Circuit Court of Appeals affirmed the convictions in an opinion written by Justice Ronald Lee Gilman. The Court rejected the Smith brothers’ complaints of insufficient evidence, that the government introduced evidence that effectively amended the indictment, that a defense witness was erroneously excluded, that their sentences were procedurally and substantively unreasonable and that their forfeiture judgment was excessive.