Who is a “Payor” Under the Texas Natural Resources Code?

by Gray Reed & McGraw
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You’ve secured the right leases.  You’ve drilled nice wells in the right locations.  Now, will you pay the right royalty owners?  Follow Devon Energy Production Company, L.P. v. Apache Corporation, to be sure that you do.

The takeaways

  • The duty to pay lessor royalties was owed by their lessee, not the operator of the wells.
  • There’s something missing from the opinion. Tune in soon for an in-depth discussion of the question that is not addressed.

The wells and the royalty hot potato

Norma Jean Hester leased her one-third undivided mineral interest in a tract to Apache.  The remaining mineral owners leased the remaining two-thirds to Devon. Devon and Apache couldn’t agree on a JOA, so Apache drilled seven producing wells and paid Devon its two-thirds share of production revenue net of Apache’s costs, leaving it to Devon to pay its royalty owners.

The Devon royalty owners sued Devon for breach of the lease and Apache for violating the Texas Natural Resources Code alleging they had not been paid all royalties due.  Devon cross-claimed against Apache alleging it was Apache’s duty as operator to pay the Devon royalty owners directly even though Apache did not have leases with them.

The rule of equitable accounting between cotenants

  • A cotenant has the right to extract minerals from common property without first obtaining the consent of his cotenants; however, he must account to them on the basis of the value of any minerals taken, less necessary and reasonable costs of production and marketing.

Statutory liability for royalties

  • Texas Natural Resources Code Section 91.402(a) requires that proceeds from the sale of production be paid to each payee by the payor on or before 120 days after the end of the month of first sale from the well. Thereafter, payments must be made timely according to the frequency of payment specified in the lease or other written agreement between the payee and payor.

The ruling

Devon, not Apache, was obligated to pay the Devon royalty owners. The Court focused on “payor” and “payee” in the statute.  A “payor” is “the party who undertakes to distribute … proceeds to the payee, whether as the purchaser of the production of oil or gas generating such proceeds or as operator of the well from which such production was obtained or as lessee under the lease on which royalty is due.”  A “payee” is “any person legally entitled to payment from the proceeds derived from the sale of oil or gas from an oil or gas well … .”

Apache could not be a “payor” under the statute because it did not “undertake” to pay the Devon royalty owners—it didn’t even have a lease with them.  Even though Apache was the “operator of the well from which … production was obtained,” it was not a “payor” under Section 91.402(a).  Paying the Devon royalty owners was Devon’s problem, not Apache’s.

But what about an NPRI?

Devon argued that Texas courts have interpreted “payor” to include the operator of the well, even if it doesn’t have a lease with the royalty owner, citing Prize Energy v. Cliff Hoskins, Inc.  But Prize involved an non-participating royalty interest, not a lease royalty. Lease royalty interests are “creatures of the oil and gas lease”, whereas an NPRI does not relate to any particular lease and is more typically tied to the land.  Thus, it doesn’t matter whether an operator has a lease with an NPRI owner; the operator becomes a “payor” and the NPRI owner a “payee” as soon as a well is drilled on the NPRI-burdened tract.

A musical interlude having nothing really to do with the topic.

[View source.]

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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