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Louisiana Department of Revenue Attempts to Rewrite Crude Oil Purchase Agreements in an Effort to Collect More Severance Taxes

Posted in Legal Updates, Tax

The Louisiana Department of Revenue and Louisiana oil producers continue to battle over the imposition of severance tax on oil and condensate produced in Louisiana.  Gordon Arata Montgomery Barnett partner Martin Landrieu has posted previously on the Department’s attempt to charge hundreds of thousands of dollars in “delinquent taxes” the Department claims is owed under oil purchase agreements; that post can be accessed here.  Litigation on this issue is intensifying.

The contract price in a standard oil purchase agreement is commonly structured using several adjustable pricing components followed by a fixed component referred to as a “premium or deduct.”  The premium or deduct is negotiated by the parties and takes into account various factors specific to the particular field at issue including, among other things, distance of the well from the selling point, quality and quantity of the oil purchased, speculation, risk of loss, marketability and the bargaining power of the parties.  The adjustable components are used to calculate what is called the “Base Price,” from which the fixed premium or deduct is subtracted.  The Department has stated its position that any such deduct should be categorized as an unallowed “transportation deduction,” while Louisiana oil producers and their customers take the stance that any such deduct (or premium) is part of the price of the oil as negotiated under the contract.

The Department has initiated audits and has formally assessed dozens of oil companies in Louisiana with a claim that delinquent severance taxes, together with penalties and interest, are owed for oil severed from the ground and water in Louisiana under contracts as described above.  That is, the Department is claiming that any deduct component should be categorized as an unallowed transportation deduction and added back into the price for severance tax purposes, resulting in an increase in the price of the oil, even though the parties negotiated the price to be otherwise and the oil producer never received that incremental amount.

In support of its assessments, including interest, penalties, and fees, the Department points to Revenue Information Bulletin No. 08-015, which takes the position that the transportation deduction allowed by 61 LAC Pt I, § 2903(A)(h) is limited to transportation which transports oil off lease and excludes the movement of oil on lease, which the Department categorizes as “gathering activities,” and, therefore, not considered “transportation.”  The transportation deduction in § 2903 states in its entirety:

Transportation Costs—there shall be deducted from the value determined under the foregoing provisions the charges for trucking, barging, and pipeline fees actually charged the producer. In the event the producer transports the oil and/or condensate by his own facilities, $0.25 per barrel shall be deemed to be a reasonable charge for transportation and may be deducted from the value computed under the foregoing provisions. The producer can deduct either the $0.25 per barrel or actual transportation charges billed by third parties but not both. Should it become apparent the $0.25 per barrel charge is inequitable or unreasonable, the secretary may prospectively re-determine the transportation charge to be allowed when the producer transports the oil and/or condensate in his own facilities.

As the previous post noted, the Department’s recent assaults have the effect of essentially rewriting the contract price two parties agreed upon for the purchase of crude oil in the open marketplace.  Louisiana law, however, simply states that you tax the value of the oil and condensate at the time and place of severance.  If there is no posted field price, which, there generally is not these days, the value of the oil and condensate at the time and place of severance is determined by the gross receipts received by the producer from the first purchaser, less charges for trucking, barging and pipeline fees (i.e. transportation costs).  This method of calculating the value of the oil is aimed at getting to the true value of the oil at the moment it is severed from the earth, that is at the wellhead.  It is common sense that if the producer of oil has to expend extra costs to get the oil to the point of sale once it is severed from the earth, that cost will be added to the price the first purchaser pays, but it is not part of the true value of the oil at the time and place of severance.  Following the same logic, if the producer and purchaser engaged in an arm’s length transaction agree that a premium or deduct is necessary in order to better reflect the true value of the oil at the time and place of severance, that premium or deduct constitutes part of the value of the oil and should not be unilaterally added back into the price in direct contradiction to the words of the statute and regulation.

Additionally, it is important to note that nowhere in the provision allowing for a transportation deduction is there a distinction between transportation which takes place “on lease” versus “off lease.”  As Judge Morvant of the 19th JDC recently recognized in Mantle Oil & Gas, LLC v. La. State Revenue Department, Case No. 646215, § 2903 simply states that if the producer incurs “charges for trucking, barging, and pipeline fees” in order to get the oil to the point of sale, he may deduct those costs from the price of oil for severance tax purposes.  Judge Morvant’s decision provides hope that Louisiana courts recognize that the Department’s recent attacks on oil and gas producers in Louisiana are in direct contradiction to the law and infringe upon parties’ determinations of the market value of oil at the point of severance.

In some instances the Department has taken an alternative approach, claiming that the value of oil for severance tax purposes is the price per barrel published as a “market center price” in one or more published index price bulletins (e.g. NYMEX or ARGUS Petroleum).  In other words, the Department has treated a published “market center price” as the statutory equivalent of “posted field price.”  The Department has stated its position on this issue as follows:

The only issue on the schedules is that the contract deductions have been disallowed and added back to the taxable value of the oil.  The statute imposing the oil severance tax (47:633(7)(a)) states that the taxable value of oil is the higher of (1) the gross receipts received from the first purchaser, less charges for trucking, barging and pipeline fees, or (2) the posted field price.  Based on the Louisiana Administrative Code’s definition of posted field price as it relates to the oil severance tax statute, the Department of Revenue has taken the position that the index price bulletins used in contracts are today’s equivalent of the posted field price, and therefore the contract deductions are deductions from the posted field price (number 2 in the statute above).  Since the statute taxes the higher of gross receipts or the posted field price, we have added the contract deductions back to the taxable price per barrel.

The Department’s position on “posted field price” has been rejected by courts in the past, and does not appear to be supported by the facts this time around either.

In a new twist in a few of the more recent cases, the Department of Revenue has gone so far as to allege fraud and unclean hands on the part of some oil producers and has asserted that they entered into contracts that provide for deductions for certain costs in the determination of the purchase price for the purpose of reducing the severance tax owed.

Stay tuned!

Please feel free to call Martin Landrieu, Caroline Lafourcade or Michael Landis if you have any questions about your severance tax issues.

Fifth Circuit Upholds “Subsequent Purchaser Rule” For Mineral Leases

Posted in Mineral Leases, News

On April 18, 2017, the United States Court of Appeals for the Fifth Circuit held in Guilbeau v. Hess Corp. (Docket No. 16-30971) that Louisiana’s subsequent purchaser rule applies to rights arising under mineral leases.  The ruling surely comes to the relief of the oil and gas industry concerned over uncertain liability to third parties with whom oil companies had no privity of contract.

The subsequent purchaser rule in Louisiana, as articulated in Eagle Pipe & Supply Co. v. Amerada Hess Corp. (79 So. 3d 246 (La. 2011)), is based on the premise that although injury to property is damage to the real rights in the property, the right to sue another who infringes upon that real right is a personal right, which belongs to the owner of the real right (that is, the owner of the property) at the time the damage is inflicted.  (Id. at 279.)  Thus, the theory goes, “an owner of property has no right or actual interest in recovering from a third party for damage which was inflicted on the property before his purchase, in the absence of an assignment or subrogation of the rights belonging to the owner of the property when the damage was inflicted.”  (Id. at 256–57.)

The Court’s opinion in Eagle Pipe contained a conspicuous footnote, in which the Court expressed “no opinion as to the applicability of [the subsequent purchaser rule] to fact situations involving mineral leases or obligations arising out of the Mineral Code.”  (Id. at 281 n.80.)  Enter, Guilbeau, who seized on this language to argue that there is uncertainty whether the rule applies to mineral leases.  The land at issue, which Guilbeau purchased in 2007, had earlier been leased to Hess’s predecessor for oil and gas operations.  The operations ceased in 1971, and the lease terminated in 1973.  By the time Guilbeau purchased the property, all wells had been plugged and abandoned.  The federal court for the Western District of Louisiana dismissed the case, holding that the subsequent purchaser rule barred Guilbeau’s cause of action.

The Fifth Circuit agreed with the district court and recited decisions from the Louisiana First Circuit (Global Marketing Solutions, L.L.C. v. Blue Mill Farms, Inc., 153 So. 3d 1209 (La. Ct. App. 2014)), Second Circuit (Wagoner v. Chevron USA, Inc., 55 So. 3d 12 (La. Ct. App. 2010); Walton v. ExxonMobil Corp., 162 So. 3d 490 (La. Ct. App. 2015)), and Third Circuit (Bundrick v. Anadarko Petrol. Corp., 159 So. 3d 1137 (La. Ct. App. 2015); Boone v. Conoco Phillips Co., 139 So. 3d 1047 (La. Ct. App. 2014)), all of which applied the subsequent purchaser rule to hold that a plaintiff, as owner of land, cannot recover for damages that arose on a leased premises before the plaintiff  acquired the same premises.  In Walton, however, the Second Circuit noted that although a purchaser cannot recover for damages that occurred under a mineral lease before the purchaser acquired its interest in the land/lease, a purchaser may still recover for damages that occur after the purchaser’s acquisition of its interest in the land/lease.

Finding no persuasive data to suggest that the Louisiana Supreme Court would rule differently from this consensus among the Louisiana appellate courts, the Fifth Circuit ruled similarly and upheld the district court’s ruling that, absent an assignment or subrogation, a purchaser of property may not recover for damages incurred under a mineral lease before the purchaser’s acquisition of an interest in the property/lease.

Louisiana Governor Issues State of Emergency for Coastal Louisiana

Posted in News

On April 18, 2017, Louisiana Governor John Bel Edwards issued a State of Emergency for Coastal Louisiana. Proclamation No. 43 JBE 2017 outlines the national importance of the Louisiana coastline and many continuing threats it faces and specifically identifies alleged damage caused by the energy industry.  In response to the deteriorating coastline, the Louisiana Coastal Protection and Restoration Authority developed “Louisiana’s Comprehensive Master Plan for a Sustainable Coast,” often referred to as the Coastal Master Plan.  The 2017 update of that plan was unanimously approved by the Louisiana Coastal Protection and Restoration Authority and has been sent to the Louisiana Legislature for approval.  The proclamation finds the Louisiana coast to be “in a state of crisis and emergency that requires immediate and urgent action and attention.”

Gov. Edwards has sent a letter to President Trump requesting that the federal government designate five important integrated coastal protection projects, including the Coastal Master Plan, for “high priority status.” He has also called on the state and federal legislatures to implement laws and regulations “expediting or creating exemptions for permitting and environmental review currently necessary to implement integrated coastal protection in coastal Louisiana.”  The emergency extends for 30 days, from April 18 to May 17, 2017.

There has been speculation that Gov. Edwards issued this proclamation as a strategic step to help pursue the land loss cases filed in parishes within the Coastal Zone against various stakeholders in the oil and gas industry, including operators, lessees, and pipeline companies. It is currently unknown how this proclamation may affect the Governor’s authority in hiring outside counsel for these lawsuits or the Attorney General Landry’s position over the prosecution of these lawsuits.

Recent Developments on Interrupting Prescription of Non-Use of a Mineral Servitude

Posted in Mineral Code

With the Louisiana Second Circuit’s recent opinion in Smith v. Andrews, it seems a good time to revisit the law on interruption of prescription of non-use of mineral servitudes.  In Smith, the landowners attempted a full-frontal, but ultimately unsuccessful assault to have the court rule that a mineral servitude burdening their land had prescribed for non-use.  The courts’ methodical rejection of their various theories provides a good platform for reviewing the applicable law.

Prescription of non-use of a mineral servitude can be interrupted numerous ways. Under Article 29 of the Louisiana Mineral Code, prescription is interrupted by good faith operations for the discovery and production of minerals.  To be in good faith, operations must be:

1)   commenced with reasonable expectation of discovering and producing minerals in paying quantities at a particular point or depth,

2)   continued at the site chosen to that point or depth, and

3)   conducted in such a manner that they constitute a single operation.

Under this first requirement, operations must be commenced with reasonable expectation of discovering and producing minerals in paying quantities at a particular point or depth.  Thus, an operator drilling an oil or gas well must have reasonable expectation that there are paying quantities of oil or gas at the depth to which he intends to drill.  The reasonableness of these expectations can be proven by testimony of geologists, experienced oil men, or both.  Under the second requirement, a well must actually be drilled at the chosen site to the depth at which there were reasonable expectations that oil or gas would be discovered.  It is enough that a well is actually drilled; the well does not have to be a producer.  Thus, a dry hole suffices to interrupt prescription assuming the other good faith requirements are met.  But if an operator abandons or aborts before the target depth is reached (in either that same well or a substitute thereof if that first well encounters problems), the operations will not interrupt prescription.  Under the third requirement, the operations must be conducted in such a manner that they constitute a single continuous operation although actual drilling or mining is not conducted at all times and may actually include multiple wells if, for instance, the initial well encounters problems.

Although numerous Louisiana courts have addressed whether particular drilling operations constituted use of a mineral servitude sufficient to interrupt prescription, no single test has yet been established for all circumstances. The Louisiana Second Circuit’s decision in Smith v. Andrews, 51,186 (La. App. 2 Cir. 2/15/17), although not yet final and still subject to Supreme Court review, is the latest development in Louisiana jurisprudence on what constitutes sufficient operations for purposes of interruption of prescription and, therefore, maintenance of a mineral servitude.

In Smith, Billy Joe and Betty Ruth Andrews owned several tracts of land in DeSoto Parish, Louisiana.  But their land was burdened by two mineral servitudes: one granted to Union Central Life Insurance Company predecessor by merger to Ameritas Life Insurance Corporation (“Ameritas”) and another in favor of a group referred to as the Smith Heirs.  In 1966, the mineral servitude owners granted mineral leases to Mallard Drilling Corporation.  Thereafter, Mallard drilled several successful wells on the Andrews’ land.  Over time, all but one of Mallard’s wells ceased producing.  The last producing well, the Rogers No. 1 Well, is the subject matter of this lawsuit.

In 1990, Mallard assigned its leases to Quest, who was operating the Rogers No. 1 Well at the time. At some point in the 1990s, the Andrews alleged that Quest damaged a road on their land, so Quest agreed to share certain profits in the well with the Andrews.  Additionally, Quest hired Mr. Andrews to serve as “pumper” on the well checking on the well periodically and monitoring the amount of oil stored in the tanks.  In 1994, the mineral servitude owners executed new leases in favor of Quest (apparently as a result of the prior leases lapsing).  In 2001, Quest assigned the 1994 leases to Jordan, who was then the operator of the well.  Jordan had worked for Quest in the past and took over several wells in an attempt to get them pumping again.  Jordan operated the Rogers No. 1 well here pursuant to the Quest assignment and, according to his testimony, he believed that the assignment from Quest gave him the right to act for his own benefit and the benefit of anyone else with an interest in the lease (including the mineral owners).

In 2008, Andrews sent letters to the Smith heirs and Ameritas demanding that they acknowledge that their servitudes had prescribed. Upon inquiry with the Office of Conservation, the servitude owners discovered that, without their knowledge, Mr. Andrews had had the records changed to reflect no production after 1997; they refused to execute the releases in favor of Andrews.  Mr. Andrews contended that, as part of his activities in monitoring the well, he had witnessed the Rogers No. 1 Well stop pumping as a result of mechanical difficulties in May 1997.  Mr. Andrews represented to the Office of Conservation “that he knew what happened to the well and when, that he had records proving that production on the well stopped in 1997, and that the servitude owners were aware of it.’ Interestingly, these statements were later shown to be untruthful.

In 2009, the Smith heirs filed suit against the Andrews and others for a declaratory judgment that their servitude was still in effect. The Andrews then filed pleadings that the mineral servitudes in favor of Smith heirs and Ameritas had both prescribed for non-use from a lack of production or operations between 1997 and 2007 and thus that the Andrews (as landowners) were now the owners of the relevant mineral rights.  But after a long trial, the district court sided with the mineral-servitude owners, and the Second Circuit affirmed.  Both courts rejected the four arguments pushed by the Andrews.

First, the only evidence the Andrews presented regarding the lack of production between 1997 and 2007 was Mr. Andrews’s own testimony, which the district court found not to be credible.  The servitude owners presented sales receipts, electricity reports, expert and lay testimony to reconstruct the wells activities at that time, successfully proving that the well had actually produced through September 1998 resulting in interruption of prescription on the mineral servitudes through that date.

Second, the Andrews argued that the operation on the wells were not performed on behalf of the servitude owners, as there was no legal relationship between Jordan, the operator, and the servitude owners. Although the lease in favor of Jordan had previously lapsed under the 90 day cessation of operations provision, Mineral Code article 43 provides that a person may also act on behalf of the servitude owners to interrupt prescription “when there is clear and convincing evidence that he intended to act for the servitude owner. Based on testimony from Jordan, the operator at the time, the court found that it was clear that Jordan intended to act, not only for himself, but also the servitude owners.  Jordan testified that he was 66 years old and had over 50 years’ experience working in the oilfield, including 38 years as a pumper.  Jordan testified that he understood that the wells were subject to a lease and that any production obtained would benefit the royalty owners and the mineral servitude owners.  Jordan testified that he believed his assignment gave him the right to produce the Rogers No. 1 Well and thus that he was acting both for his own benefit and for anyone else who owned an interest in the lease.  His assignment clearly referenced the two leases from the servitude owners.  The court found all of this evidence clear and convincing and concluded that Jordan was acting to make money for both himself and the servitude owners, and, thus, intended to act for, among others, the servitude owners.

Third, the Andrews argued that the operator did not obtain enough production sufficient to interrupt the prescription of non-use. Citing the comments to Mineral Code article 38, the Andrews contended that, to interrupt prescription, production must be in an amount sufficient to put to a beneficial use.  But the court swiftly rejected this novel theory.  The text of article 38 is clear: “To interrupt prescription, it is not necessary that minerals be produced in paying quantities.  It is necessary only that minerals actually be produced in good faith with the intent of saving or otherwise using them for some beneficial purpose.”  The record clearly demonstrated that Jordan produced oil in good faith in accordance with the statutory requirements.

Finally, the Andrews argued that Jordan’s actions in “bumping” the well were insufficient to constitute operations for purposes of interruption of the mineral owners’ servitudes. They insisted that, under the statute, the operator must perform operations involving equipment actually in the bore hole and that Jordan’s activities were not “intimately connected with the resolution of the difficulty that caused the well to cease production in order to constitute reworking.”  In support, the Andrews cited the following comments to Mineral Code article 39:

Once actual production of minerals has ceased, operations seeking to restore production or to secure new production from the same site may be conducted. It is felt that as long as such operations are conducted in good faith and in accordance with the basic principles stated in Articles 29 through 31, they should constitute an interruption of prescription.  Insofar as the petroleum industry is concerned, Article 39 should be construed to include any good faith reworking operations or operations for recompletion of the well in another sand that involve use of equipment in the well bore.

The court reasoned that Article 39 clearly states that either good faith reworking operations or operations for recompletion of the well in a different sand that involve the use of equipment in the wellbore will interrupt prescription.  Although it involved the sufficiency of reworking operations within the scope of the contractual provisions in a mineral lease rather than for purposes of maintaining mineral servitudes such as here, the Supreme Court’s discussion on reworking operations in Jardell v Hillin Oil Co., 485 So. 2d 919 (La. 1986), is pertinent here.  After analyzing several earlier cases that considered the definition of “reworking” as used in mineral lease and similar contract provisions in the oil and gas industry, the Court concluded that reworking operations at least include the following:

Any process or procedure which you may undertake to either regain, increase or create new production in a well or activity to restore or increase production of a well that has been drilled[,] usually the second attempt or to work again on a well. In a well that has produced it would be an operation when the well came off of production or ceased production, and it would be an operation to maintain, restore, improve production.

The Jardell court ultimately held that the lease at issue therein did not terminate under its cessation of production clause, for the lessees had commenced good faith reworking operations within 90 days of the shut in of the well. In Smith, the well had ceased to produce because a pump was stuck.  The court found that Jordan’s actions in jarring the well to unstick the pump and restore production (albeit for a short period of time to follow) constituted good faith reworking operations under the reasoning in Jardell.

The Louisiana Supreme Court case of Nelson v. Young, 255 La. 1043, 234 So. 2d 54 (1970) is historically significant to the ruling in Smith.  In Nelson, the surface owner granted leases even though he did not own the minerals.  In 1959, the lessee drilled a well, which produced until 1964.  In 1967, the mineral servitude owners filed suit to be declared owners of the mineral rights.  The trial court dismissed the suit.  But the Second Circuit reversed.  Thereafter, the Supreme Court affirmed the Second Circuit, relying on the theory of quasi-contract based on the approving silence of the servitude owners when the lease was executed by the landowner and production was established thereunder.  Pursuant to the apparent acquiescence of the mineral servitude owner, the landowner’s act became the servitude owner’s act, thus interrupting prescription.

The reasoning of Nelson was not enthusiastically received by all.  It appeared to be contrary to jurisprudence that no act by a landowner should have the effect of interrupting prescription unless he intended it to do so.  As a result of much criticism, the redactors of the Mineral Code legislatively overruled Nelson in 1975 with the adoption of Mineral Code article 43.  Mineral Code article 43 specifically defines when a person is deemed to have acted on behalf of the servitude owner and includes the scenario present in Smith where an operator’s intent to act on behalf of the servitude owner is evident.

In Smith, the court ultimately held that the prescription of non-use of the mineral servitudes was interrupted by good faith reworking operations conducted by a person who, based on clear and convincing evidence, had the intention to act on behalf of the mineral servitude owners in his attempts to regain production from the well, thereby making use of the mineral servitude for their benefit.  In short, the Smith decision reminds us that the actual beliefs/intent of an operator can sometimes make all the difference.

Two Gordon Arata Montgomery Barnett Lawyers Scheduled to Speak at HAPL’s 48th Annual Technical Workshop

Posted in News

Mike Fussell and David Rogers are scheduled to speak at the Houston Association of Professional Landmen’s (HAPL) 48th Annual Technical Workshop on Tuesday, April 18.  They will give a “Multi-State Case Law Update” and address cases covering issues that attorneys and landmen practicing in the area of oil, gas and mineral law should be aware of no matter the basin or state in which they are working.  The cases covered will be applicable for in-house landmen, field landmen and attorneys rendering advice on the issues covered including the definition of production in paying quantities under a mineral lease in order to maintain a lease and the proper descriptions needed for a mineral transfer. Mike and David will also discuss the differences among states concerning certain issues such as whether minerals may be held in perpetuity and the surface use rights of mineral owners among other issues.

James D. “Doug” Rhorer Recognized as a Leader in Law by New Orleans CityBusiness

Posted in News

Gordon, Arata, Montgomery, Barnett, McCollam, Duplantis & Eagan, LLC is pleased to announce that James D. “Doug” Rhorer has been recognized as a member of the “Leadership in Law Class of 2017” by New Orleans CityBusiness.

Doug practices in the areas of oil and gas law, construction law and general commercial litigation.  He has successfully represented exploration and production companies and natural gas pipeline companies in various litigation matters, including “legacy” lawsuits arising from historical oil and gas operations.  Doug also advises owners, architects, contractors and project managers on a wide range of legal issues, including lien laws, change order disputes, bid protests, acceleration claims and delay claims.  He regularly negotiates and drafts construction contracts, professional services agreements and solicitation documents for both private and public works projects.

Doug has made pro bono representation a priority in his practice. In 2016, he received the Louisiana State Bar Association’s Pro Bono Century Award.  For two years in a row, the Pro Bono Project awarded him the Century Award in 2016 and the 100+ Hour Award in 2015.  Recently, Louisiana Super Lawyers named him a Rising Star.

Doug, along with other honorees, will be recognized at a cocktail reception in May at the New Orleans Museum of Art.  Following the event, a profile of his business accomplishments, community activities, and achievements will be published in a special insert in New Orleans CityBusiness.

Courts At Odds Whether Non-Operator Lessees Can Invoke LA. R.S. 30:103.1 and LA. R.S. 30:103.2

Posted in Legal Updates

Under La. R.S. 30:103.1 and 30:103.2, an unleased owner in a commissioner’s unit is entitled to reports on production and costs from a well in the unit and, in certain circumstances, statutory penalties if such reports are not timely provided.  But is a non-operator lessee entitled to the same relief?  Two recent courts have reached opposite results.  In TDX Energy, LLC v. Chesapeake Operating, Inc., 2016 WL 1179206 (W.D. 3/24/2016), the United States District Court for the Western District of Louisiana ruled that these statutes do not apply to non-operator lessees.  However, in XXI Oil & Gas, LLC v. Hilcorp Energy Co., 124 So.3d 530 (La. App. 3 Cir. 10/9/13) and 206 So.3d 885 (La. App. 3 Cir. 9/28/16), the Louisiana Third Circuit Court of Appeal applied them to a non-operator lessee. Until this conflict is finally resolved by either the Legislature or the Louisiana Supreme Court, operators should respond to non-operator lessees making demands under 103.1 for production and costs information as though the lessees do qualify as an “owner or owners of an unleased oil and gas interest” under 103.1 and 103.2.  Let’s take a closer look at the facts and the courts’ reasoning for their rulings in each case.

In TDX Energy, LLC v. Chesapeake Operating, Inc., TDX acquired several leases in a Haynesville unit operated by Chesapeake.  The unit order was dated effective September 16, 2008 and the unit well was spud in February 2011 and completed on July 19, 2011.  TDX acquired its leases from Touchstone Energy, LLC in October 2011.  The leases were taken by Touchstone between July 18, 2011 and September 14, 2011; they were all dated effective July 15, 2011, but were not recorded until after the well was completed.  In fact, Chesapeake was not aware of the TDX leases until TDX sent it a request for a report on the well in accordance with 103.1 in December 2011.  Chesapeake responded by letter and provided the well costs and invoked the risk fee statute.  [See our earlier blog article on the application of the risk fee statute to the TDX case.]

Thereafter, TDX sued Chesapeake in federal court to recover production payments, accounting, penalties, and attorney’s fees under 103.2 for its failure to provide the information required under 103.1.  A central issue litigated in the case was whether TDX, as a non-operator lessee, was able to invoke 103.1 for these well reports and to assert the penalty under 103.2 against Chesapeake.

For reference, Louisiana Revised Statute 30:103.1 reads as follows:

  1. Whenever there is included within a drilling unit, as authorized by the commissioner of conservation, lands producing oil or gas, or both, upon which the operator or producer has no valid oil, gas, or mineral lease, said operator or producer shall issue the following reports to the owners of said interests by a sworn, detailed, itemized statement:

(1)        Within ninety calendar days from completion of the well, an initial report which shall contain the costs of drilling, completing, and equipping the unit well.

(2)        After establishment of production from the unit well, quarterly reports which shall contain the following:

(a)        The total amount of oil, gas, or other hydrocarbons produced from the lands during the previous quarter.

(b)        The price received from any purchaser of unit production.

(c)        Quarterly operating costs and expenses.

(d)       Any additional funds expended to enhance or restore the production of the unit well.

  1. No operator or producer shall be required under the provisions of this Section to report any information which is not known by such operator or producer at the time of a report. However, the operator or producer shall report the required information to the owner of the unleased interest within thirty days after such information is obtained by the operator or producer, or in the next quarterly report, whichever due date is later.
  2. Reports shall be sent by certified mail to each owner of an unleased oil or gas interest who has requested such reports in writing, by certified mail addressed to the operator or producer. The written request shall contain the unleased interest owner’s name and address. Initial reports shall be sent no later than ninety calendar days after the completion of the well. The operator or producer shall begin sending quarterly reports within ninety calendar days after receiving the written request, whichever is later, and shall continue sending quarterly reports until cessation of production.
  3. Notwithstanding any other provision of this Section to the contrary, at the time a report is due pursuant to this Section, if the share of the total costs of drilling, completing, and equipping the unit well and all other unit costs allocable to an owner of an unleased interest is less than one thousand dollars, no report shall be required. However, during January of the next calendar year, the operator or producer shall report such costs to the owner.

La. R.S. 30:103.2 states the penalty for not complying with 103.1 and reads as follows:

Whenever the operator or producer permits ninety calendar days to elapse from completion of the well and thirty additional calendar days to elapse from date of receipt of written notice by certified mail from the owner or owners of unleased oil and gas interests calling attention to failure to comply with the provisions of R.S. 30:103.1, such operator or producer shall forfeit his right to demand contribution from the owner or owners of the unleased oil and gas interests for the costs of the drilling operations of the well.

Chesapeake argued on appeal that TDX should not be afforded the remedy under 103.2 because it does not qualify as an “owner or owners of unleased oil and gas interests.”  TDX contended that the phrase contained in 103.2 “owner or owners of unleased oil and gas interests” is a shorthand method of referring to the oil and gas interests within a unit that are unleased by a unit operator such as Chesapeake in this instance.

The court agreed with Chesapeake and found that 103.2 was penal in nature and, therefore, should be strictly construed. Furthermore, the court found that 103.2 is clear and unambiguous as written and that applying 103.2 solely to lands unencumbered by mineral leases does not lead to absurd consequences.  The court then looked to the text of 103.2 and 103.1 to try to discern the legislative intent behind both. Unable to do so, the court then looked at other statutes within Title 30 including La. R.S. 30:111 and La. R.S. 30:10 for clues as to what the phrase “owners of an unleased oil or gas interest” means.

The relevant portion of La. R.S. 30:111 reads as follows:

Owners of unleased mineral interests and lessees in any drilling unit authorized by the department of conservation of this state, shall not be liable or obligated to pay to the operator or producer for materials furnished or used in the drilling, completion, and production of any oil, gas, or mineral well drilled on said unit a sum in excess of the prevailing market price of such materials.

The relevant portion of La. R.S. 30:10(A)(2)(e) as it read in 2011 when the well at issue was drilled reads as follows in pertinent part:

The provisions … above with respect to the risk charge shall not apply to any unleased interest not subject to an oil, gas and mineral lease

The court noted that in La. R.S. 30:111 the words lessees and unleased mineral interest are both included as two separate and distinct terms.  Thus, the court reasoned, the legislature understood that “owners of unleased mineral interests” refers to owners of mineral interest unleased by anyone.  It pointed to the language in La. R.S. 30:10(A)(2)(e) to suggest that “unleased interest” means a mineral interest not leased by either the operator or a non-operator lessee.  Thus, the court determined that in some instances the legislature intended to give greater protection to unleased owners than mineral lessees.  Therefore, the court held that 103.1 and 103.2 do not apply to non-operator lessees. Note that this case is currently up on appeal at the United States Court of Appeal for the Fifth Circuit.

In XXI Oil & Gas, LLC v. Hilcorp Energy Co., Hilcorp Energy Company recompleted the Trahan No. 1 Well as a unit well in a commissioner’s unit on January 11, 2011.  The next month, XXI Oil & Gas, LLC acquired several mineral leases covering minerals underlying lands located within the unit.  In April 2011, XXI sent a certified letter to Hilcorp requesting reports containing the costs of recompleting the Trahan Well and the production information associated with the well. That same day Hilcorp sent XXI a letter stating that the Trahan Well had casing damage and would not flow. The letter attached an AFE showing a cost estimate to recomplete the Trahan Well and an invoice in the amount of $40,737.33. A representative of XXI signed the letter evidencing that it agreed to participate in the recompletion of the Trahan Well.

In June 2011, XXI sent Hilcorp a letter stating that Hilcorp had failed to provide it with a “sworn, detailed statement of revenues and expenses” for the Trahan Well within 90 days of the recompletion and within thirty days of XXI’s April 2011 letter.  As a result, XXI stated that Hilcorp could not deduct the costs of recompleting or operating the Trahan Well from XXI’s share of revenues.  Hilcorp did not respond further.  XXI then sued for penalties under103.2.  The trial court granted XXI’s motion for partial summary judgment on the issue whether XXI was entitled to the penalty under 103.2 for Hilcorp not complying with 103.1.  The trial court found that Hilcorp did not comply with 103.1 because the statement of costs it submitted to XXI was not sworn and detailed. XXI was granted its share of revenue from the Trahan Well without the deduction of the costs of drilling operations (the penalty under 103.2).

On appeal, Hilcorp argued that the trial court erred in granting XXI’s motion for partial summary judgment because a genuine issue of material fact existed whether the leases taken by XXI were valid.  Second, Hilcorp argued that the trial court erred in applying 103.1 against Hilcorp.  But it is unclear whether Hilcorp ever argued that 103.1 and 103.2 do not apply to non-operator lessees such as XXI.  The court dismissed Hilcorp’s first assignment of error by stating that the issue whether the leases were valid was not relevant to the appeal and is an issue suitable for a trial on the merits. The court further noted that, should the leases be found to be invalid, then XXI would receive no revenue from which Hilcorp could deduct production cost.

Concerning the second assignment of error whereby Hilcorp argued that the AFE it sent to XXI sufficed to satisfy the intent and purpose of 103.1, the court first looked at whether 103.1 was ambiguous as written.  The court found 103.1 to be unambiguous and thus that it must be applied as written; however, it is unclear whether the court was just addressing the question of what constitutes a sufficient report under the statute, as opposed to the question whether the statute applies to lessees. In determining whether Hilcorp complied with 103.1 as written, the court found that the AFE provided by Hilcorp lacked the detail “relevant to such a document.”  In discussing the detail needed in the reports required under 103.1, the court stated the report must tell the unleased mineral owner what it is getting for its money.  However, ultimately the court found the AFE inadequate because it was not a sworn statement.  Because the AFE was not sworn, the court ruled that it was inadequate under 103.1 and, as a result, the 103.2 remedy was available to XXI.

On remand, the trial court found Hilcorp liable to XXI for penalties under 103.2 in the amount of $367,231.30 representing all revenue from the Trahan Well attributable to the XXI leases.  Hilcorp filed a second appeal assigning as error the application by the trial court of 103.1 and 103.2 to XXI as a non-operator lessee.  In making this argument, Hilcorp cited the TDX case.  But the Third Circuit cited its previous opinion and maintained its position that a non-operator lessee has a claim to an accounting under 103.1 as an owner of a valid oil, gas or mineral lease.  In its written opinion, the court did not explain its reasoning any further as to 103.1 applying to non-operator lessees.

Both the court in TDX and the court in XXI agreed that 103.1 and 103.2 are unambiguous as written.  However, they reached opposite results.  The court in TDX appeared to focus on what is meant by “owner or owners of unleased oil and gas interest” and whether that language was meant to include non-operator lessees.  Although the court in XXI appeared to not directly address the issue whether a non-operator lessee may invoke either statute and focused more on the proper method to comply with 103.1 and the reach of the penalty under 103.2, it nonetheless ruled in favor of a non-operator lessee. The end result is two conflicting conclusions reached by the courts. Therefore, in order to avoid the penalty under 103.2, operators should properly respond within the delays allowed under 103.1 to a non-operator lessee who seeks production and cost information until further clarity is given by the courts or the legislature.

Gordon Arata and Montgomery Barnett to Merge

Posted in News

New Orleans, LA – The law firms of Gordon, Arata, McCollam, Duplantis & Eagan, LLC and Montgomery Barnett, L.L.P. announce their merger to become Gordon, Arata, Montgomery, Barnett, McCollam, Duplantis & Eagan, LLC, effective March 1, 2017.  Gordon Arata Montgomery Barnett will have offices in New Orleans, Lafayette, Baton Rouge, and Houston.

For nearly half a century, Gordon Arata has been best known as one of the preeminent oil and gas law firms in Louisiana.  Founded in 1892, Montgomery Barnett is a distinguished admiralty, maritime, and business law firm.  Their merger will dovetail these core practice areas, and create strong synergies in commercial litigation, arbitration and mediation, bankruptcy, construction, employment, financing, insurance, real estate, and taxation.

“We are excited to merge with Montgomery Barnett’s group of distinguished lawyers.  This merger will expand the existing services of both firms and provide additional resources to handle matters for clients across diverse industries,” said Tim Eagan, Managing Member of Gordon Arata.

“Our firms share similar cultures and a commitment to provide the highest level of service to our clients.  With a deep bench of talented attorneys in both firms and complimentary practice areas, an optimal merger opportunity presented itself,” said Philip “Chip” S. Brooks, Jr., Managing Partner of Montgomery Barnett.

Stronger as one, Gordon Arata Montgomery Barnett commits to forging enduring client relationships, working with clients to solve complex legal challenges, and delivering top notch legal services effectively and efficiently across the full range of its practice areas.

UPDATE: BOEM Withdraws Sole Liability Orders Issued Under NTL 2016-01

Posted in BOEM

The Bureau of Ocean Management (BOEM) announced that it will withdraw its orders issued in December 2016 to provide additional security for sole-liability properties to Outer Continental Shelf (OCS) oil and gas lease and grant holders.  “Sole-liability properties” are leases, rights of way (ROWs) and right of use easements (RUEs) for which there are no co-lessees/co-owners and no prior interest holders responsible for the outstanding obligations.  BOEM stated the reason for the withdrawal is “to allow time for the new Administration to review the complex financial assurance program” and that it will welcome “continued industry engagement on [the] important issue [of financial assurance].”  As you may be aware, the sole liability concept has raised numerous issues and concerns.  For example, because RUEs cannot be conveyed, BSEE has considered each platform and other facility under a RUE to be a sole liability asset, even if such platform or facility was also covered by a prior RUE or, as is often the case, by an earlier oil and gas lease so that multiple parties have accrued liability for the decommissioning of such platform or facility.  A similar issue arises for pipeline ROWs.  Although BSEE’s predecessor (the MMS) had allowed ROWs to be owned by more than one party, BSEE now does not grant, or approve assignments for, split-ownership of ROWs.  Thus, BSEE has categorized many ROWs as sole liability assets, even though those ROWs and the associated pipe are in fact owned by multiple parties.

As our recent blogs posted on January 6, 2017 and January 9, 2017 have discussed, BOEM previously announced a six-month delay of the effectiveness of NTL 2016-01 for non-sole liability properties.  BOEM will now also consider any implementation issues associated with the sole liability orders as part of its review of the NTL.  Despite the six-month extension, operators and lessees on the OCS should be aware that “BOEM may re-issue sole liability orders before the end of the six-month period if it determines there is a substantial risk of nonperformance of the interest holder’s decommissioning liabilities.”

The effective date of the NTL was pushed to March 12, 2017 by the six-month delay.  As the effective date fast approaches, we expect that the current supplemental bonding uncertainty facing OCS lessees and operators will continue as BOEM may either revise the NTL or further delay its implementation.

Texas appellate court rules that mineral leases with municipalities are worth more than the paper they are written on

Posted in Legal Updates

On February 7, 2017, a Texas appellate court ruled that the city of Dallas must face a $200 million lawsuit filed back in 2014, where a driller alleged that the city acted improperly by entering into a mineral lease with the company and then denying it permits to drill—effectively rendering the lease worthless. See City of Dallas v. Trinity East Energy, LLC, No. 05-16-00349-CV (Tex. App.- Dallas Feb. 7, 2017).  Dallas had argued that it was immune from suit because it was acting in a governmental function when it entered into the lease; however, the court held that the city was actually acting in a proprietary function and therefore was not immune.

Trinity East Energy, LLC signed a mineral lease with the city to drill for oil and gas, but then the city of Dallas refused to approve Trinity’s applications for permits to drill. Trinity in turn sued for breach of contract and inverse condemnation.  As the court in City of Midlothian v. Black, 271 S.W.3d 791 (Tex. App.- Waco 2008), explained, “inverse condemnation” occurs when “a governmental entity physically appropriates or invades the property, or when it unreasonably interferes with the landowner’s right to use and enjoy the property, such as by restricting access or denying a permit for development.”  Dallas maintained that it was immune from suit.  The district court agreed, finding that the city was immune and thus beyond the reach of the court.

The appellate court reversed, in part, and rejected Dallas’s immunity arguments based on recent Texas Supreme Court precedent in Wasson Interests, Ltd. v. City of Jacksonville, 489 S.W.3d 427 (Tex. 2016) that “sovereign immunity does not imbue a city with derivative immunity when it performs proprietary functions.  This is true whether a city commits a tort or breaches a contract, so long as in each situation the city acts of its own volition for its own benefit and not as a branch of the state.”

Dallas attempted to argue that these transactions were an exercise of its governmental functions in the regulation of parks, floodplains, building codes and inspections when it entered into the leases and that the grant or denial of a specific use permit is a zoning change- a governmental function. But the court held that the conduct at issue clearly implicated Dallas’s proprietary function because the actions were taken not for the benefit of the entire state, but rather for the benefit of only those who live within the city’s corporate limits.  As a result, the city was not immune from suit.  However, the court also concluded that “even if the City was acting in its governmental capacity, Trinity alleged a viable claim for inverse condemnation.”

This decision will likely provide a good measure of comfort to drillers in the Texas area who take leases from municipalities. If this decision is left to stand, drillers should have comfort that cities cannot pull the rug out from under them and leave them holding a worthless lease that cannot be worked.  And while Dallas may be reeling from this decision, in the long-run it might actually be to its benefit.  If drillers had to worry that they would be left without recourse after leases from cities were nullified by their failure to issue permits, it is likely that the market for such leases would dry up, or at least become way less attractive.  We will keep you posted on whether the Texas Supreme Court decides to take up this issue.