In Gladney v. Anglo-Dutch Energy, L.L.C., the Third Circuit addressed the question of whether or not a mineral lessee must pay its lessor full lease-basis royalties for production undertaken during the effective period of a conditional allowable but prior to the effective date of a unit order.[1] In the case, the Plaintiffs granted a mineral lease to the Defendant-Lessee that provided for a 1/5 royalty in 2009.[2] The Defendant-Lessee drilled a gas well on the leased premises on February 14, 2012.[3] The well, which was to produce from a reservoir and zone under the property of multiple landowners, was completed on April 27, 2012 and began production on May 18, 2012.[4] Shortly before the well went on production, the Defendant-Lessee commenced proceedings for the creation of a compulsory unit for the well and the applicable reservoir and zone with the Office of Conservation.[5] Because the Defendant-Lessee did not obtain a lease-basis allowable for the well prior to filing its pre-application notice for creation of the unit, the Defendant-Lessee sought a conditional allowable for the well, which was granted on May 17, 2012, and which was conditioned on an agreement with the Office of Conservation that provided as follows:
All monies generated from the date of first production, the disbursement of which is contingent upon the outcome of the current proceedings before the Office of Conservation for the Frio Zone will be disbursed upon results of those proceedings.[6]
Several months later, the Commissioner issued an order establishing the unit, and the order stated that it “shall be effective on and after October 30, 2012.”[7]
In 2013, the Plaintiffs made demand on the Defendant-Lessee on the grounds that “despite the October 30, 2012 effective date of the Commissioner’s Order, [the Defendant-Lessee] refused to pay Plaintiffs their full [1/5] Lessor’s Royalty” pursuant to the mineral lease between the parties.[8] The Plaintiffs’ primary argument was that while royalties could be paid on a “unit tract” basis after the effective date of the Commissioner’s Order, Plaintiffs were entitled to their full 1/5 royalty, on a lease-basis, from the date of first production until the effective date of the Commissioner’s Order.[9] The Defendant-Lessee contended that Plaintiffs were not entitled to their full lease-basis 1/5 royalty because the issuance of the conditional allowable required them to pay on a unit-basis and replaced its obligation under the mineral lease to pay full lease-basis royalties.[10] The trial court accepted the Defendant-Lessee’s argument.[11]
The Third Circuit reversed and remanded and ultimately found that the Plaintiffs were entitled to their full 1/5 lease-basis royalty from the date of first production until the effective date of the unit. The Court’s primary reasoning was that the conditional allowable did not abrogate the contractual terms of the mineral lease between the Plaintiffs and the Defendant-Lessee:
the Office of Conservation does not attempt to interpret private mineral leases and other private contracts, as they are beyond its jurisdiction and authority.” Yuma v. Thompson, 98-1399 (La. 3/2/99), 731 So.2d 190, 197. In Arkansas Louisiana Gas Co. v. Southwest Natural Production Co., 60 So.2d 9, 11 (La. 1952), the Louisiana Supreme Court explained that the Commissioner of Conservation, when establishing a drilling unit, “did not intend to, and did not, in fact, abrogate the contracts between the several lessors and their respective lessees with respect to the nature or structure of their mineral ownership, or alter in any way the consideration to be paid and the method of payment.” The trial court’s judgment holding that Anglo-Dutch’s royalty obligations under the Mineral Lease were abrogated by the terms of the conditional allowable is in direct contrast to this longstanding rule that the Commissioner nor his office should alter private contractual rights.[12]
In addition, the Court noted the testimony of a former presiding officer over unitization proceedings who stated that:
[t]he issuance of a conditional allowable is not intended to affect in any manner the private contractual obligations of an operator or lessee on whose land is situated a well which is the subject of a unit application.” He also stated “[t]he Office of Conservation issues a conditional production allowable without consideration of, and without prejudice to, any private contractual rights between the operator and the landowner-lessee on whose lands the well is drilled.[13]
The Court also rejected the Defendant-Lessee’s argument that the Plaintiffs’ claims were a collateral attack on the Commissioner’s authority because the Plaintiffs were not attacking the Commissioner’s conditional allowable but simply seeking to enforce their rights under the mineral lease.[14] Finally, the Court rejected the Defendant-Lessee’s argument that it had no choice but to pay royalties on a unit-basis because payment of the full 1/5 lease-basis royalty would have resulted in double royalties.[15] In its reasoning, the Court noted that the Defendant-Lessee could have modified its lease obligations through a royalty escrow agreement, an option which Plaintiffs had suggested, but the Defendant-Lessee did not give the Plaintiffs such an option.[16]
Ultimately, the Gladney decision provides mineral lessees with clear instructions regarding the payment of royalties on production undertaken prior to the effectiveness of a unit. In addition, it shows that mineral lessees, when faced with situations that could be resolved by escrow or other alternative agreements, should undertake such steps in order to avoid potential litigation and/or royalty demands.
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[1] 16-468 (La. App. 3 Cir. 12/21/16). Opinion available at http://www.la3circuit.org/Opinions/2016/12/122116/16-0468opi.pdf. At the time of this update, the legal delays for rehearing and/or further review of this decision by the Louisiana Supreme Court have not expired.
[2] See id. at 3.
[3] See id.
[4] See id.
[5] See id.
[6] See id. at 4.
[7] See id.
[8] Id.
[9] See id.
[10] See id. at 4-5.
[11] See id. at 5-6.
[12] Id. at 7-8.
[13] Id. at 8.
[14] See id. at 10-12.
[15] See id. at 12.
[16] See id. at 12-13.