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When an operator mistakenly overpays a royalty owner, it can recoup the overpayment from future royalties.  While this is a common industry practice, the doctrine of equitable recoupment is seldom discussed in detail by Texas courts.  Recently, however, the Fifth Circuit provided an in-depth overview of the doctrine of equitable recoupment in its opinion affirming a district court decision from the Western District of Texas in DDR Weinert, Ltd. v. Ovintiv USA, Inc.

The dispute centered on whether Ovintiv USA, Inc. (“Ovintiv”), the operator and lessee, was permitted to recoup overpayments that were made two years prior to a prior lessor (“the Richters”) from the successor lessors, DDR Weinert, Ltd. and DDR Williams, Ltd. (“Plaintiffs”), two entities owned and controlled by the Richters.  The Richters owned several tracts of land in Karnes County, Texas (the “Subject Property”), and Ovintiv was the lessee and operator of the Subject Property.  In December 2017, the Richters conveyed their mineral interests in Subject Property to the Plaintiffs.  As such, the Plaintiffs became the successor lessors of the Subject Property.

In September 2016, Ovintiv mistakenly adjusted the gas flow on the Subject Property; this error resulted in Ovintiv overpaying the Richters royalties.  Ovintiv did not discover its error until January 2018.  Once Ovintiv discovered the mistake, it notified Plaintiffs that “it planned to conduct a ‘Prior Period Adjustment’ that year and would recoup any overpayments to the Richters from future royalty payments to the Plaintiffs.”  Plaintiffs sued Ovintiv in Texas state court on April 27, 2022, alleging that Ovintiv withheld over $608,000 in royalties from them.  On the basis of diversity jurisdiction, Ovintiv removed the lawsuit to the Western District of Texas, and the district court granted summary judgment for Ovintiv.  Plaintiffs appealed, and the Fifth Circuit affirmed.  The Fifth Circuit’s decision focused on the doctrine of equitable recoupment.

The Fifth Circuit explained that for the doctrine of equitable recoupment to apply, two requirements must be met: “‘(1) some type of overpayment must have been made, and (2) both the creditor’s claim and the amount owed the debtor must arise from a single transaction.’” Neither party disputed that an overpayment was made; thus, the Fifth Circuit only considered whether the overpayment arose “from a single transaction.”

Guided in large part by one of its previous rulings, W & T Offshore Inc. v. Bernhardt, F.3d 227, 241 (5th Cir. 2019), and a seminal Texas Supreme Court case, Gavenda v. Strata Energy, Inc., 705 S.W.2d 690, 692 (Tex. 1986), the Fifth Circuit concluded that Ovintiv’s overpayment arose from a single transaction and, thus, the doctrine of equitable recoupment barred the Plaintiffs’ claims.  In W & T Offshore Inc., the Fifth Circuit held that, for recoupment purposes, each monthly payment under a lease is part of the same transaction; applying that ruling here, the Fifth Circuit concluded that Ovintiv’s overpayment of royalties arose from a single transaction.  Next, relying on Gavenda, the Court examined whether application of doctrine of equitable recoupment would prevent Ovintiv from being unjustly enriched.  The Court reasoned that if the Plaintiffs were to succeed, “Ovintiv ‘would pay the amount of overpayment twice—once to the overpaid royalty owner . . . and again to the [Plaintiffs] through [t]his suit.’” Two facts of particular importance were that (1) Ovintiv did not profit from underpaying the Plaintiffs and (2) the Plaintiffs are entities controlled by the Richters.  Thus, if the Plaintiffs were to prevail, both the Richters and Plaintiffs would be unjustly enriched.  The Court also noted that the Plaintiffs could bring a claim for unjust enrichment against the Richters.  Therefore, the Fifth Circuit concluded that the doctrine of equitable recoupment applied and estopped the Plaintiffs’ claims against Ovintiv.

For more information about how recent rulings may affect royalty interests or operational practices, contact Liskow attorneys Jana Grauberger, James Kittrell, and Margaret Chavez, and visit our Royalty Litigation practice page.