Ambiguity Sends An Overriding Royalty Dispute Back To The Trial Court

by Gray Reed & McGraw

It must be maddening to non-lawyers that a large segment of an industry can operate in harmony by agreeing that a contract in widespread use means one thing, only to have party-crashers decide it means another. Total E & P U.S.A., Inc. v. Kerr-McGee Oil & Gas Corp. et al arose out of assignments of overriding royalty interests in an offshore Louisiana lease. The assignments had “calculate and pay” clauses stating that the assigned interest “shall be calculated and paid in the same manner and subject to the same conditions as the landowner’s royalty under the Lease.” The Outer Continental Shelf Deep Water Relief Act suspended the federal government’s royalty until 87.5 million BOE had been produced. Lessees Total and Statoil argued that the calculate and pay clauses also suspended payment of the overrides. The other working interest owner, Chevron, disagreed and paid on the overrides.

Reversing a district court ruling in favor of the lessees, the 5th Circuit said the assignment was, at the very least, ambiguous.

An overriding royalty is different from a lessor’s royalty.

The court relied upon the “well-recognized distinction between overriding royalty interests and a lessor’s royalty” under Louisiana law. According the court, an overriding royalty is in addition to the royalty paid to the landowner. Thus, the court disagreed with the trial court that the language had to explicitly state that the royalty suspension would not apply to the overrides.

Because the assignments did not explicitly state that the suspension of the federal government’s royalties counter-intuitively applied to the overrides, the contracts were ambiguous. Furthermore, the assignments stated the overrides shall be paid out of “all oil, gas, and casinghead gas … produced, saved, and marketed from the lease.” This broad language indicated that the royalty would be calculated based on total production, and not merely on the period in which the federal government was entitled to its royalty.

You go your way, I’ll go mine

The aspect of the case likely to frustrate the override owners the most was an expert’s survey, ignored by the trial court (but not by the appeals court because they took the time to mention it) that in 80 other overriding royalty instruments with language like the that at issue no other party interpreted the provisions so as to subject the overrides to the DWRRA royalty suspension.

A concurring opinion arrived at the same conclusion – the agreements were ambiguous – from another direction, relying on the structure of the calculate and pay clause to create the ambiguity. The meaning turned on what portion of the clause was modified by “in the same manner and subject to the same terms and conditions”.  If you want more grammar, I respectfully refer you to the opinion.

What next?

The case was remanded for a trial at which extrinsic evidence, perhaps including the report on the 80 similar agreements and Chevron’s position, will be admitted to determine the intent of the parties.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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