Devon Energy Prod. Co., et al. v. Sheppard, et al is your kind of case if you are in search of:

• A roadmap for slicing and dicing royalty calculations in myriad ways,
• Pretty good summaries of the Supreme Court’s notable decisions in Heritage Resources v. NationsBank,  Judice v. Mewborne Oil, Chesapeake Exploration v. Hyder and Burlington Resources v. Texas Crude. (pp 12-19)
• A description of the gas fractionation process.
• For you scriveners: Reference to the Supreme Court’s lament for “the considerable time, money and heartache” expended due to the use of “industry jargon, outdated legalese, or tenuous assumptions about how judges will interpret industry jargon or outdated legalese”.

The royalty clause

The lessor’s royalty is addressed in three paragraphs of several oil and gas leases:

• 3(a)-(b), a standard provision that the royalty is to be a percentage of Devon’s gross proceeds from the sale to downstream purchasers;
• Addendum L, which says royalties are free of cost; and
• 3(c) (the language at issue):

“If any disposition, contract or sale of oil or gas shall include any reduction or charge for the expenses or costs of production, treatment, transportation, manufacturing, process or marketing of the oil or gas, then such deduction, expense or cost shall be added to the market value or gross proceeds so that Lessor’s royalty shall never be chargeable directly or indirectly with any costs or expenses other than its pro rata share of severance or production taxes”

The litigation

The parties stipulated to 23 issues (pp 41 – 49), each asking whether lessee Devon violated the leases by failing to add particular amounts to the total figure upon which lessor Sheppard’s royalty payments were based. The trial court ruled in favor of Sheppard on all 23 disputed issues.

On appeal Sheppard argued that Devon violated the “shall be added” words in 3(c), by failing to add back to the base royalty to be paid an $18/barrel “reduction” in the sales price attributable to gathering, handling and transportation of produced gas.

In responding to this and other issues, broadly speaking, Devon argued that this was a “gross proceeds” royalty. Devon made payments based on gross proceeds without deduction for post-production expenses but without any additions.

According to Sheppard, 3(c) expressly contemplated the addition of certain sums to the gross proceeds in order to arrive at the royalty base. The court of appeals agreed, opining that taking Devon’s position would render paragraph 3(c) meaningless.

Each of the 23 stipulated issues fell within one of the following six categories:

• adjustment of fixed amount with stated purpose,
• adjustment of fixed amount without stated purpose,
• adjustment based on processor’s actual costs,
• adjustments for unit fuel-lease fuel,
• adjustment for production retained or lost by third parties, and
• excess value resulting from application of contractually fixed recovery factors.

See pp. 31- 41 for details.

The court held that Devon was required to pay royalties on amounts attributable to certain post-production costs specified in the leases, even costs that were are born by a downstream purchaser rather than by Devon.

The result of the decision was that under 3(c), the addition of certain amounts to the gross proceeds before calculating royalty meant that the royalty base may end up being larger than the proceeds received by Devon.

A word about relying on “precedent” (This is not about you, John Roberts)

Each lease must be construed in accordance with its unique language. Heritage didn’t apply here because the lease language was different. Language might be surplussage in one lease but not another. You have to consider the entire agreement.

Rhetorical question: Is choice of venue ever at work in these cases?

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