CASE LAW UPDATE. WILLIAM B. BURFORD Kelly Hart & Hallman LLP Post Office Box 3580 Midland, Texas 79702

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1 CASE LAW UPDATE WILLIAM B. BURFORD Kelly Hart & Hallman LLP Post Office Box 3580 Midland, Texas Permian Basin Landmen s Association Monthly Meeting November 8, 2016 Midland, Texas

2 TABLE OF CONTENTS I. Oil and Gas Titles and Conveyancing A. Hysaw v. Dawkins (Tex.) B. Greer v. Shook (El Paso) C. Laborde Properties v. U.S. Shale Energy II (San Antonio) D. Bounds v. Prud Homme (Beaumont) E. Goss v. Addax Mineral Fund (Amarillo) F. Wenske v. Ealy (Corpus Christi) II. Land Descriptions Mueller v. Davis (Texarkana) III. Royalty calculation Chesapeake Exploration v. Hyder (Tex.) IV. Retained Acreage A. ConocoPhillips Co. v. Vaquillas Unproven Minerals (San Antonio) B. XOG Operating v. Chesapeake Exploration (Amarillo) V. Mineral Trespass Lightning Oil v. Anadarko (San Antonio) VI. Overriding Royalty Interests Apache Deepwater v. McDaniel Partners (Tex.) VII. Bona Fide Purchaser Jackson v. Wildflower Production Co. (Amarillo) VIII. Paying Quantities A. BP America Production Co. v. Red Deer Resources, LLC (Amarillo) B. BP America v. Laddex (Amarillo) Case Law Update 2016 PB OGL Paper.DOC

3 IX. New Mexico T. H. McElvain Oil & Gas LP v. Benson-Montin-Greer Drilling - 3 -

4 I. Oil and Gas Titles and Conveyancing Case Law Update 2016 PB OGL Paper.DOC Case Law Update PBLA Monthly Meeting November 8, 2016 William B. Burford A. WILL CONSTRUED TO HAVE DEVISED EQUAL 1/3 FRACTIONS OF ANY ROYALTY, NOT JUST THE STATED 1/3 OF 1/8 The Texas Supreme Court in Hysaw v. Dawkins, 483 S.W.3d 1 (Tex. 2016), construed the will of Ethel Nichols Hysaw, who died owning a 1065-acre tract, a 200-acre tract, and a 150- acre tract of land in Karnes County, Texas. In her will she devised 600 acres out of the acre tract to her daughter Inez Hysaw Foote, 465 acres out of the 1065-acre tract to her daughter Dorothy Frances Hysaw Burris, and the 200-acre and 150-acre tracts to her son Howard Caldwell Hysaw, Jr., all subject to the proviso that each of my children shall have and hold the undivided one-third (1/3) of an undivided one-eighth (1/8) of all oil, gas or other minerals in or under or that may be produced from any of said lands, the same being a non-participating royalty interest. The same section of the will reiterated that each child would not need to obtain the consent of the others to lease his or her respective tract but would receive one-third of oneeighth royalty, provided there is no royalty sold or conveyed by me covering the lands so willed to her [or him], and should there be any royalty sold during my lifetime then the [three children of the testatrix] shall each receive one-third of the remainder of the unsold royalty. When Inez s descendants leased her tract for 1/5 royalty and a producing well was drilled, Howard s and Dorothy s descendants sought a declaratory judgment that all three children were to share all royalty from all of the land equally. Inez s descendants contended that, to the contrary, Howard and Dorothy were each devised only a fixed royalty of 1/24 of production from Inez s tract so that Inez s descendants were entitled to 1/5 of the production from Inez s tract under the current lease less Howard s and Dorothy s aggregate 1/12. The court of appeals reversed the trial court s summary judgment for Howard s and Dorothy s descendants and rendered judgment for Inez s. The supreme court reversed the court of appeals, holding that the will, when construed as a whole, devised to each child 1/3 of any and all royalty on production from any of the land. The court of appeals had departed from the appropriate analytical approach, the supreme court explained, by construing each royalty provision in isolation. Double fractions in a mineral conveyance may or may not evince an intent to fix the interest; the use of 1/8 sometimes embodies the parties expectation that a future lease will provide the typical 1/8 landowner s royalty with no intent to convey a fixed fraction of gross production. In this case the court reaffirmed its commitment, it said, instead to a holistic approach aimed at ascertaining intent from all words and all parts of the conveying instrument. Apparent inconsistencies or contradictions must be harmonized, to the extent possible, by construing the document as a whole. But meaning derived without reference to context, by segregating key

5 terms and phrases as the court believed the court of appeals had done, is not confirmed merely because a construction would not produce an inconsistency with another provision. Absent other indicators of testamentary intent, the court observed, it might be plausible to read the double-fraction royalty devise of 1/3 of 1/8 to each child as a mathematical expression describing a fractional royalty, so that any excess royalty must default to the fee owner. Other language in the will, however, and the overall structure of the royalty devise confirmed, in the court s analysis, Ethel s intent to treat her children equally in the distribution of the devised royalty interests. Evidencing Ethel s intent to equally divide the royalties among the children, the court found, were (1) the deliberate recitation of identical language to effect each child s royalty devise; (2) the use of double fractions in lieu of single fractions, with one fraction connoting equality among the three children (1/3) and the other raising the specter of the estate misconception or use of the then-standard 1/8 royalty as a synonym for the landowner s royalty ; (3) the first royalty provision s global application to all the children and the second provision s language restating the royalty devise of each child individually; and (4) to the court most tellingly of the testamentary intent, the equal-sharing language in the third and final royalty clause. The only plausible construction supported by a holistic reading of the will, the court concluded, was that Ethel had used one-eighth royalty as shorthand for the entire royalty interest a lessor might retain under a lease. The court acknowledged that court opinions construing double-fraction language have yielded mixed results, with no discernible unifying principle except to the extent the outcome derives from the conveying instrument s specific language. One reading of this opinion, with its emphasis on eschewing mechanical, arbitrary, and bright-line rules, is that no such principles are possible and that one can be certain of the construction of a royalty expressed as a fraction of one-eighth only if absolutely identical language has been definitively construed in an earlier case, if then. The estate misconception theory (the discredited misunderstanding that a landowner retains only 1/8 of the minerals in place, rather than a fee simple determinable, after executing an oil and gas lease) and the historical use of 1/8 as the standard royalty may inform the meaning of fractions stated in multiples of 1/8, but these considerations are not alone dispositive, the court emphasized. Oil and gas title examiners and others regularly faced with the interpretation of royalty conveyances and reservations are unlikely to take much comfort from this case, though the court s general approach that intent is to be gathered from all parts of a document, not particular words and phrases considered in isolation can scarcely be questioned. Clearly the words of 1/8 (or a single fraction that is itself a fraction of 1/8) cannot be ignored or read as though they were of any and all royalty without some other words that evince that intention; but exactly what words are needed and in what context may often be a matter of conjecture. Not to say that the court has done so here, but there seems a real danger that some courts may be tempted to abuse the holistic approach to double-fraction royalty interpretation to suit their own, possibly ill-informed, suspicions of the parties intent

6 B. DEED CONSTRUED TO HAVE CONVEYED FLOATING 1/2 OF ROYALTY, NOT FIXED 1/16 OF PRODUCTION OR 1/16 OF ROYALTY The court in Greer v. Shook, No CV, 2016 WL (Tex. App. El Paso Oct. 19, 2016, no pet. h.), construed a 1927 deed from Lynn Eddins to John Borden pertaining to 3,200 acres of land in Reeves County, Texas that was at the time of the deed subject to an oil and gas lease providing for payment of 1/8 royalty to the lessor. Affirming the trial court s summary judgment, the court declared the deed to have unambiguously conveyed onehalf of the royalty on production reserved under any oil and gas lease so that the successors to the grantee s interest were entitled to 1/2 of the 1/4 royalty payable under current leases. The Eddins-Borden deed, in its granting clause, first conveyed an interest described as an undivided one-sixteenth (1/16) interest in and to all of the oil, gas and other minerals in and under, and that [which] may be produced from the land, [t]ogether with the right of ingress and egress at all times for the purpose of mining, drilling, and exploring said land for oil, gas and other minerals, and removing the same therefrom. Subsequent clauses of the deed, in addition to providing that it was not necessary for the grantee to join in future leases, making the conveyed interest non-participating, provided as follows: 4. Be it expressly understood between the parties that the vendor is the owner of all of the royalty and that the grantee is purchasing one half (1/2) of the royalty one half (1/2) of the minerals, produced in and from wells or other operations situated on the specific tract of land described in this instrument. 5. [S]aid land now under an oil and gas lease executed in favor of John Ross, it is understood and agreed that this sale is made subject to the terms of said lease, but covers and includes one half (1/2) of all of the oil royalty, and gas rental or royalty due and to be paid under the terms of said lease. 6. It is understood and agreed that none of the money rentals which may be paid to extend the term within which a well may be begun under the terms of said lease is to be paid to the said Grantee and in [the] event that the above described lease for any reason becomes cancelled or forfeited, then and in that event an undivided one sixteenth (1/16) of the lease interest and all future rentals on said land for oil, gas and other mineral privileges shall be owned by said Grantee, he owning one sixteenth of all oil, gas and other minerals in and under said lands, together with no interest in all future rentals. Emphasizing that deeds must be construed by giving effect to all of their provisions, harmonizing those that appear to conflict if possible, the court rejected the argument made by the successors to the grantor s interest that the interest the deed conveyed in future leases should be considered as separate and different from the interest it conveyed during the existence of the lease that was in effect in 1927, while also rejecting the argument made by the successors to the grantee s interest that the interest was wholly royalty in character, not a mineral interest. It concluded Eddins, the grantor, had used the fraction 1/16 where it appeared in the deed as shorthand for expressing that he intended to convey 1/2 of what he believed was his remaining - 6 -

7 1/8 mineral interest in the land, a manifestation of the estate misconception doctrine. This interpretation harmonized the inconsistent fractions, the court pointed out, and was consistent with the grantor s apparent intent, it found, since there was nothing in the deed to indicate that he may have intended to convey 1/2 of his 1/8 royalty under the current lease but a radically reduced 1/16 of the royalty under future leases. The estate the deed conveyed, the court held, consisted of a permanent 1/2 mineral interest, both before and after the expiration of the oil and gas lease in effect at the time, which included a corresponding 1/2 floating interest in the royalty under both the existing and future leases. This case vividly illustrates the pronounced reluctance of Texas courts ever to find ambiguity in mineral and royalty conveyances and reservations. The court s interpretation of the deed here is convincing, but whether it is really the only reasonable one seems open to question. C. ROYALTY RESERVATION CONSTRUED AS FIXED INTEREST IN PRODUCTION In Laborde Properties, L.P. v. U.S. Shale Energy II, LLC, No CV, 2016 WL (Tex. App. San Antonio Oct. 12, 2016, no pet. h.) (mem. op.), the court construed a 1951 deed from J. E. Bryan and Minnie H. Bryan to S. E. Crews, conveying a tract of land in Karnes County, Texas, to have reserved to the grantors a royalty interest consisting of a fixed 1/16 of total production, not a floating one-half of the royalty provided for in a subsequent lease. The interest reserved, according to the deed, was the following interest: an undivided one-half (1/2) interest in and to the Oil Royalty, Gas Royalty and Royalty in other Minerals in and under or that may be produced or mined from the above described premises, the same being equal to one-sixteenth (1/16) of the production. The property became subject to an oil and gas lease providing for a 20% royalty to the lessor. When a producing well was completed under that lease, a dispute arose between U.S. Shale and the Bryan heirs, successors to the grantors interest, and Laborde Properties, successor to the grantee s interest. U.S. Shale and the Bryans contended they were entitled under the deed to 1/2 of the current 20% royalty, or 10% of total production; Laborde maintained that the U.S. Shale and Bryan interest in production to be deducted from Laborde s interest was only 1/16 of production. U.S. Shale and the Bryans filed suit for a declaratory judgment and secured a summary judgment in favor of their construction. The court of appeals reversed and rendered judgment in favor of Laborde that the reserved royalty interest was a fixed royalty of 1/16 of production rather than a floating onehalf of any royalty. It acknowledged that the one-half (1/2) interest in and to the Oil Royalty wording was indicative of a floating interest but observed that the same being equal to onesixteenth (1/16) of the production denoted a fixed interest. Considering all of the deed s provisions holistically, however, attempting to harmonize and give effect to all of its contents, the court discerned that a fixed royalty was intended. To construe the reservation as a floating royalty would in the court s view, in the absence of any language in the deed indicating a - 7 -

8 contrary intention, require it to ignore the phrase the same being equal to one-sixteenth (1/16) of the production. Other cases in which such fixed-royalty wording was present but a deed was nevertheless construed to have reserved a floating royalty, the court explained, relied on other provisions within the deed indicating the parties intention. Here the court found no such indicative wording. Instead, the same being equal to one-sixteenth (1/16) of the production qualified, modified, or clarified the preceding undivided one-half language, it said, showing an intention to reserve a fixed interest. If the parties had intended to reserve a floating interest, according to the court, the deed would not have included the phrase of the production. D. HEADING OF TABULAR DEED FORM GIVEN NO EFFECT IN DETERMINING WHETHER MINERALS RESERVED The court in Bounds v. Prud Homme, No CV, 2016 WL (Tex. App. Tyler Mar. 31, 2016, pet. filed) (mem. op.), construed six deeds in which members of the Prud Homme family conveyed a 126-acre tract in San Augustine County, Texas to Walter and Carolyn Bounds. The Boundses contended that the deeds had conveyed to them the one-half mineral interest the grantors owned in the land, and the Prud Hommes maintained that the deeds had reserved the mineral interest to themselves. The deeds were in tabular form, with a granting clause that conveyed the land subject to the reservations from and exceptions to the conveyance and warranty contained in the deed under a preceding reservations and exceptions heading. That heading and the wording inserted after it were as follows: Reservations from and Exceptions to Conveyance and Warranty: TITLE to any of the oil, gas and other minerals, in, under and that may be produced from the above-described real property, together with all rights, privileges and immunities relating thereto, including the following: There followed descriptions of two deeds in which one-half of the minerals underlying the land had been reserved to prior grantors. Reversing the trial court, the court of appeals held that the deeds reserved no interest to the grantors. The text immediately after the reservations and exceptions heading, a sentence fragment lacking a verb, made sense, according to the court, only when read in conjunction with the two paragraphs identifying the prior mineral reservations. It merely stated that there were mineral reservations in the earlier deeds but did not, in the court s reading, specify that the grantor was reserving any mineral interest. It did not explicitly create a new right, and the court would not, it said, interpret the deed as creating a reservation by implication. At most, the language following the heading was an exception to the warranty. This case may illustrate the confusion to real property sellers and buyers, as well as courts, that can be brought about by the use of popular tabular deed forms promulgated by wellmeaning attorneys organizations. The court s opinion takes issue with the ungrammatical structure of the wording that followed the reservation and exception heading, but it seems to ignore altogether the words of the heading. The court s decision might have been different, one - 8 -

9 supposes, if the words appearing after the heading had been preceded by Grantor excepts from this conveyance and reserves to Grantor. The court fails to explain why title to any of the oil, gas and other minerals in, on, under and that may be produced from the above-described real property should not be considered an item that is identified by the heading as a reservation from and exception to conveyance, to which reservation the grant is expressly thereafter made subject. It is also not made clear why any of the oil, gas and other minerals in and under the land, in the absence of such words following them as heretofore reserved or conveyed should not be construed the same as all of the minerals. E. TABULAR DEED FORM CONSTRUED TO HAVE RESERVED MINERALS TO GRANTORS The court in Goss v. Addax Mineral Fund, LP, No CV, 2016 WL (Tex. App. Amarillo Apr. 21, 2016, pet. denied) (mem. op.), construed a 1994 deed from W. L. and Alma Bell to Kestrel Properties, Inc., conveying a tract of land in Montague County, Texas. Although the contract for the sale of the land had specified that Kestrel was to receive 100% of minerals, royalties and timber interest, the deed, in tabular form with a granting clause making the conveyance subject to the reservations from and exceptions to conveyance and warranty, included in the following preceding passage: RESERVATIONS FROM AND EXCEPTIONS TO CONVEYANCE AND WARRANTY: Reservations, restrictions and easements of record, and current year ad valorem taxes. LESS, SAVE AND EXCEPT HEREFROM ALL OIL, GAS AND OTHER MINERALS, IN, UNDER AND PRODUCED FROM THE ABOVE DESCRIBED PROPERTY. Kestrel, the grantee, dissolved in 2006, and its assets passed to David V. Goss, its sole shareholder. Nicholas Bell, the grandson of the grantors and the successor to their interest, conveyed any interest he owned in the minerals to Addax Mineral Fund, LP in In 2013 Goss filed suit to quiet his title, alleging that the 1994 deed had unambiguously conveyed the minerals to Kestrel and that the reservation and exception language merely removed the mineral interest from the deed s warranty. The court of appeals disagreed and affirmed the trial court s summary judgment for Addax. Goss emphasized the distinction between reservations and exceptions, pointing out that the wording only purported to except the minerals and arguing that it was not a reservation to the Bells but only a limitation on their warranty of title. The court acknowledged that courts recognize that reservations and exceptions are not strictly synonymous but observed that an exception may leave title in the grantor, even though not expressed as a reservation, if the excepted interest is not outstanding in another. No one in this case suggested that any interest in the minerals in the Bells tract was outstanding in a third party, so the wording less, save and except herefrom all oil, gas and other minerals left title to the minerals in the Bells whether considered an exception or a reservation. Moreover, the reservation being unambiguous, Goss was barred by the four-year statute of limitations from seeking reformation of the deed

10 F. GRANTEE S MINERAL INTEREST HELD SUBJECT ONLY TO PROPORTIONATE SHARE, NOT ALL, OF OUTSTANDING ROYALTY INTEREST The court in Wenske v. Ealy, No CV, 2016 WL (Tex. App. Corpus Christi Jan. 28, 2016, pet. filed) (mem. op.), construed a 2003 deed from Benedict and Elizabeth Wenske to Steve and Deborah Ealy, conveying a 55-acre tract of land. At the time of the deed the Wenskes owned the land subject to a non-participating royalty interest of 1/4 of the royalty, reserved to Marian Vyvjala and Margie Novak in a 1988 deed to the Wenskes. The Wenskes deed to the Ealys was made expressly subject to each of (1) a reservation of an undivided 3/8ths of all oil, gas, and other minerals in and under and that may be produced from the land, and (2) an Exception of Undivided one-fourth (1/4) interest in all of the oil, gas, and other minerals in and under the herein described property, reserved by [Vyvjala], et al... in an instrument recorded in Volume 400, Page 590 of the Deed Records of Lavaca County, Texas,... reference to which instrument is here and now made for all purposes. In their 2013 petition for a declaratory judgment, the Wenskes contended that they owned under the deed a 3/8 mineral interest free and clear of the 1/4 interest in the royalty reserved by Vyvjala and Novak. The court of appeals affirmed the trial court s summary judgment for the Ealys, holding that the Wenskes interest was burdened proportionately by the outstanding royalty interest. The construction of the Wenske-Ealy deed would seem to be governed, in the grantors favor, by Bass v. Harper, 441 S.W.2d 825 (Tex. 1969), in which the deed in question, conveying an undivided 1/2 interest in a 90-acre tract, made the conveyance subject to deeds in which prior grantors had reserved, in the aggregate, 3/7 of the royalty. This meant, according to the Bass court, that the grantee s 1/2 interest must bear the entire burden of the outstanding royalty interest so that the deed conveyed only 1/14 (1/2 minus 3/7) of the royalty to the grantee. In this case the Corpus Christi court purported to distinguish Bass on the basis that it had dealt solely with fractional ownership of the minerals themselves, not about how to apportion a separate royalty estate that corresponds with the minerals. Not only does this seem to be a patent misreading of Bass; it is unclear why it would be an important distinction if true. The court also pointed out that the deed s description of the previously reserved interest was incorrect, referring to it as a 1/4 mineral interest rather than 1/4 of the royalty. The court disagreed with the Wenskes that they could be unburdened by the outstanding royalty simply by stating that they conveyed the property subject to the exception in the 1988 deed without mentioning anything about royalties or stating that the prior royalty would be borne entirely by the Ealys. Why simply stating that the conveyance was subject to the exception of the outstanding royalty should not be sufficient to accomplish that result, as it had been in Bass, is left unexplained. Because the deed provided no guidance on how to apportion the outstanding royalty interest (or at least no guidance the court recognized), it said, the default rule should apply: that ordinarily a royalty interest is carved proportionately from the two mineral interests. For that proposition the court cited Pich v. Lankford, 302 S.W.2d 645, 650 (Tex. 1957), which does

11 contain an offhand statement to that effect, without context or discussion, but in no way stands for it. In what seems a telling footnote, the court observed that to the extent that the Wenskes argued that the outstanding royalty only attached to the Ealys 5/8 mineral interest, it disagreed because that would decrease the amount of royalties Vyvjala and Novak would receive. The court s evident belief that it was somehow impossible for an interest consisting of 1/4 of the royalty to be carved out of a 5/8 mineral interest may demonstrate a basic misunderstanding of the nature of royalty and mineral interests. This case must be considered an anomaly. Particularly in view of the court s failure to provide any comprehensible explanation of its reasoning, it is difficult to regard it as authority in the construction of deeds made subject to mineral and royalty reservations and exceptions. II. Land Descriptions CONVEYANCE OF ALL MINERAL INTEREST OWNED BY GRANTOR IN COUNTY HELD AMBIGUOUS Reversing the trial court s summary judgment in favor of the grantee, the court in Mueller v. Davis, 485 S.W.3d 622 (Tex. App. Texarkana 2016, pet. filed), construed deeds from Virginia Rose Mitchell and James Hammond Mills to James Davis. The deeds specifically conveyed the grantors interests in the minerals in Lands identified as specified amounts of acreage out of several loosely described parcels, such as acres out of the G. W. PETTY, ET AL, A-582, ET AL, known as the AMOCO PRODUCING COMPANY JOHN HARRISON JR B. Each deed also included in another paragraph the following: The Lands subject to this deed also include all strips, gores, roadways, water bottoms, and other lands adjacent to or contiguous with the lands specifically described above and owned or claimed by Grantors.... Grantor hereby conveys to Grantee all of the mineral, royalty, and overriding royalty interest owned by Grantor in Harrison County, whether or not same is herein above correctly described. Davis, the grantee, contended that he owned the grantors mineral interests in the land that was the subject of the lawsuit. Mueller, the successor to the grantors interests under subsequent deeds from them, countered that the deeds to Davis were void because their property descriptions did not satisfy the statute of frauds. The specific descriptions in the deeds, the court first held, were insufficient as a matter of law to identify the property being conveyed, because they failed to reference another writing or otherwise to make it possible to determine the size, shape, and boundaries of the specific acreage sought to be conveyed. It then addressed Davis s contention that regardless of the sufficiency of the deeds specific descriptions, he had been conveyed the grantors mineral interests in the land in question under the deeds general grant of all of the grantors interests in the county

12 Although the words all of the mineral, royalty, and overriding royalty interest owned by Grantor in Harrison County seem unequivocal, the court held that the deeds, viewed in their entirety, were ambiguous so that the parties intention was a question of fact to be determined by trial. Relying on J. Hiram Moore, Ltd. v. Greer, 172 S.W.3d 609 (Tex. 2005), the court found it impossible to determine whether, as Davis argued, the sentence appearing to convey all of the grantors mineral interests in the county was intended to operate independently, or whether instead, as Mueller asserted, the parties intended it to be a part of and to modify the Mother Hubbard clause within the same paragraph, which clearly could not have conveyed the grantors mineral interests. III. Royalty Calculation COST-FREE OVERRIDING ROYALTY INTEREST PAYABLE UNDER LEASE HELD FREE OF POST-PRODUCTION COSTS Chesapeake Exploration, L.L.C. v. Hyder, 483 S.W.3d 870 (Tex. 2016), construed an unusual provision of an oil and gas lease between the Hyder family, as lessors, and Chesapeake, the owner of the lessee s interest, covering 948 acres of land that produced natural gas from the Barnett Shale formation in North Texas. In addition to provisions for royalty of 25% of the market value at the well of all oil and liquid hydrocarbons produced and 25% of the price received by the lessee from the sale of gas, the lease called for a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent (5.0%) of gross production obtained from directional wells drilled from the leased premises but bottomed on other land. The lease also gave the lessors the option to take their royalty in kind and contained the disclaimer that the holding in the case of Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996), shall have no application to the terms and provisions of this Lease. Chesapeake sold gas produced from the lease and also from wells drilled from surface locations on land covered by the lease and producing from other land to a marketing affiliate, which paid a price based on proceeds received from third-party sales less post-production costs such as those for gathering and transportation. Chesapeake paid the Hyders for their overriding royalty after deducting the post-production costs; the Hyders contended that Chesapeake should pay royalty on the price received by its marketing affiliate without deduction of the postproduction costs. The trial court rendered judgment for the Hyders after a bench trial, and the court of appeals affirmed. The supreme court, in a 5-4 decision, affirmed the court of appeals. The court disagreed with the Hyders argument that the requirement that the overriding royalty be cost-free could only refer to post-production costs since an overriding royalty is by nature free of production costs even if the instrument creating it does not say so. Drafters frequently specify that overriding royalty interests do not bear production costs even though it may be unnecessary to do so, the court pointed out. But notwithstanding that overriding royalty interests ordinarily bear post-production costs under Texas law, Chesapeake was required to show, the court went on, that the general term cost-free, literally referring to all costs, nevertheless could not refer to post-production costs here

13 The court rejected Chesapeake s argument that the specificity of the lease s gas royalty provision in disallowing post-production costs demonstrated that the parties did not have the same intention with respect to the overriding royalty. The detail of the royalty provision served only, if anything, to emphasize its cost-free nature, according to the court, and the simple costfree directive for the overriding royalty achieved the same end. Although the Hyders could have chosen to receive their overriding royalty production in kind and thus bear costs themselves, the court then observed, they chose not to do so in the same manner as they did for their lease royalty. The fact that the Hyders might or might not become subject to postproduction costs by taking their royalty gas in kind did not suggest that they must be subject to those costs when the royalty is to be paid in cash, the court said. The choice of how to take their royalty, and the consequences, were left to the Hyders. Accordingly, the court concluded, the cost-free in the overriding royalty provision included post-production costs. Interestingly, both the majority opinion and the four-justice dissent concurred that the lease s disclaimer of any application of the Heritage Resources holding, that express wording disallowing deduction of post-production costs was mere surplusage in a lease basing gas royalty on market value at the well, should have no bearing on the court s determination of the meaning of cost-free in this case. The author s law firm represented Chesapeake in this case. IV. Retained Acreage A. ACREAGE CAPABLE OF RETENTION AFTER LEASE S PRIMARY TERM HELD REDUCED UNDER APPLICABLE FIELD RULES Oil and gas lessors often seek to negotiate retained acreage clauses under which the lease will terminate at some point, most commonly at the end of the primary term or after a period of continuous development then in progress, except as to land on which producing wells have been drilled. Many such provisions define the amount of acreage the lessee is allowed to retain as a specified number of acres, and astute lessees negotiate for a proviso that the lease will, notwithstanding the number of acres so specified, remain in effect at least with respect to the amount of acreage the state regulatory authority requires to be allocated to each well. ConocoPhillips Co. v. Vaquillas Unproven Minerals, Ltd., No CV, 2015 WL (Tex. App. San Antonio Aug. 5, 2015, pet. granted, judgm t set aside by agreement) (mem. op.), illustrates that a clause that changes the area the lessee may retain might sometimes work in the lessor s favor. ConocoPhillips held two oil and gas leases that together embraced over 33,000 acres of land owned by Vaquillas. The lease required the lessee to release, at the end of the primary term and the cessation of any continuous drilling, land described as follows: any and all portions of this lease which have not been drilled to a density of at least 40 acres for each producing oil well and 640 acres for each producing or shut-in gas well, except that in case any rule adopted by the Railroad Commission of Texas or other regulatory authority for any field on this lease provides for a spacing or proration

14 establishing different units of acreage per well, then such established different units shall be held under this lease by such production, in lieu of the 40 and 640-acre units above mentioned.... When ConocoPhillips ceased drilling after the end of the primary term, having drilled a number of gas wells on land covered by the lease, the lessor and lessee disputed how much acreage was required to be released, Vaquillas contending the lessee could retain only 40 acres around each gas well and ConocoPhillips maintaining it was entitled to 640 acres per well. The trial court granted summary judgment for Vaquillas, the lessor, and the court of appeals affirmed. The decision turned on the effect that Texas Railroad Commission field rules had on the retained acreage clause. The field rules did not mention the amount of acreage required to be assigned to a well for either drilling or production purposes but merely prohibited the drilling of any well nearer than 467 feet from any property line or 1,200 feet from any other well. This spacing requirement, ConocoPhillips argued, did not establish different units of acreage per well, and it could retain the 640 acres per well stated in the lease. Although the field rules spacing requirement did not expressly set forth a number of acres per well, the court pointed out, the Railroad Commission s statewide Rule 38 specifies standard drilling units for any field wherein only spacing rules, either special, country [sic] regular, or statewide, are applicable. Rule 38 then provides, it went on, that if the spacing rule is , like the one applicable here, the density requirement is 40 acres per well. Because this standard acreage under Rule 38 is different from the initial acreage set forth in the retained acreage clause, this standard acreage controlled the number of acres ConocoPhillips was entitled to retain under the leases. This result may have been contrary to the lessee s expectation and intention, but the court could not, it said repeatedly, rewrite the parties agreement. B. RETAINED ACREAGE CLAUSE CONSTRUED TO PERPETUATE ASSIGNMENT AS TO SPECIFIED AMOUNT OF ACREAGE, NOT LIMITED TO DESIGNATED PRORATION UNITS The court in XOG Operating, LLC v. Chesapeake Exploration Limited Partnership, 480 S.W.3d 22 (Tex. App. Amarillo 2015, pet. filed), construed an assignment of oil and gas leases covering three sections of land containing a total of 1,625 acres, providing that at the end of the primary term the assignment would terminate except as to portions thereof described as follows: that portion of said lease included within the proration or pooled unit of each well drilled under this Assignment and producing or capable of producing oil and/or gas in paying quantities. The term proration unit as used herein, shall mean the area within the surface boundaries of the proration unit then established or prescribed by field rules or special order of the appropriate regulatory authority for the reservoir in which each well is completed. In the absence of such field rules or special order, each proration unit shall be deemed to be 320 acres of land in the form of a square as near as practicable surroundings [sic] a well completed as a gas well producing or capable of producing in paying quantities

15 Chesapeake, owner of the assignee s interest, drilled six gas wells on the land. Five of the wells were completed in a field for which Texas Railroad Commission field rules provided for a standard proration unit of 320 acres; the remaining well was subject to no field rules. Although Chesapeake could have designated up to 320 acres in Railroad Commission filings in order for the wells to be assigned the maximum allowable production per well, it instead filed certified plats assigning only a total of 802 acres to proration units for the six wells. XOG contended that at the end of the assignment s primary term, Chesapeake was entitled to retain only the 802 acres it had designated as proration units in its Railroad Commission filings. Chesapeake maintained that the assignment remained effective as to 320 acres per well, regardless of the acreage delineated in the plats it had filed, or as to all 1,625 acres. Affirming the trial court s summary judgment, the court of appeals agreed with Chesapeake. The Railroad Commission does not designate the acreage or configuration of proration units, XOG pointed out. The assignment s definition of a proration unit, it argued, must refer to the operator s filing to the commission since it stated that it meant the area within the proration unit s surface boundaries. This argument failed, according to the court, because the field rules did not prescribe the area or the boundaries of a proration unit; they merely set limits on the units an operator could designate. To give effect to XOG s argument, the court believed, would be to read into the parties agreement the intent to include within the retained acreage that acreage designated in the Form P-15 filing as to each well. The plain language of the assignment defined a proration unit as the area prescribed by applicable field rules (or 320 acres in the absence of such rules), the court observed nothing more, nothing less. The parties agreed, the court concluded, that Chesapeake would retain 320 acres for each well irrespective of what it designated as proration units in its Railroad Commission filings. V. Mineral Trespass MINERAL LESSEE HELD WITHOUT RIGHT TO PREVENT USE OF SURFACE AND SUBSURFACE FOR WELLBORES DRILLED TO ADJACENT LAND The court in Lightning Oil Co. v. Anadarko E&P Onshore LLC, 480 S.W.3d 628 (Tex. App. San Antonio 2015, pet. filed), affirmed the trial court s summary judgment for Anadarko, the lessee under an oil and gas lease on land within the Chaparral Wildlife Management Area (CWMA) in Dimmit County, Texas, against Lightning, the lessee of an adjacent tract on the Briscoe Ranch under an oil and gas lease called the Cutlass Lease. Anadarko secured an easement from the Briscoe Ranch surface owners to place drillsites on the surface overlying the Cutlass Lease, intending to drill wells 8,000 feet vertically and then deviate the wellbores to produce from the CWMA. Lightning sued to prevent Anadarko s drilling, asserting that its mineral estate under the Cutlass Lease gave it the right to exclude others, so that Anadarko was committing a trespass on Lightning s leasehold. The court of appeals held that Lightning had no such right. The surface estate owner controls the earth beneath the surface estate, the court concluded after reviewing applicable case law. The mineral owner owns the hydrocarbons and the right to produce them, it pointed out, but not the earth surrounding any hydrocarbon

16 molecules. As surface estate owner, Briscoe Ranch controlled the surface and subsurface and could grant Anadarko permission to site wells on its ranch and to drill down through the earth within the Cutlass Lease and directionally into the CWMA. Anadarko could not produce from the Cutlass Lease, but Lightning had no right to exclude others from the earth surrounding its hydrocarbons. VI. Overriding Royalties And Production Payments PRODUCTION PAYMENT EXPRESSED AS PERCENTAGE OF PRODUCTION FROM LAND HELD REDUCED WHEN SOME BUT NOT ALL BURDENED LEASES EXPIRED The court in Apache Deepwater, LLC v. McDaniel Partners, Ltd., 485 S.W.3d 900 (Tex. 2016), construed a 1953 assignment of oil and gas leases covering land in Upton County, Texas, that reserved to Hugh W. Ferguson, Jr., the assignor, from his assignment to L. H. Tyson, the following production payment interest: the title and ownership of one-sixteenth of thirty-five sixty-fourths of seven-eighths (1/16th of 35/64ths of 7/8ths, being one sixteenth of the entire interest in the production from said lands to which Assignor claims to be entitled under the terms of said respective oil and gas leases) of the total oil, gas, casinghead gas and other minerals in and under and which may be produced from the above described land, i.e., from each and both of said Surveys 36 and 37, until the net proceeds of said reserved interest in the production... shall have amounted in the aggregate to [$3,550,00.00 and 1,420,000 barrels of oil]. At the time of the assignment, four leases assigned by Ferguson to Tyson collectively covered an undivided 35/64 of the mineral estate of the described Surveys 36 and 37. Each of two leases, the Cowden 36 and Cowden 37 leases, covered 1/2, or 32/64, of the mineral estate of one of the respective surveys; the Peterman lease covered 1/64 of the mineral estate of both surveys; and the Broudy lease covered 1/32, or 2/64, the mineral estate of both surveys. The Cowden 36 and 37 leases expired in the 1990s for lack of production, but the Peterman and Broudy leases remained in effect, extended by production from other land also covered by those leases. After acquiring the Peterman and Broudy leases and new leases on the Cowden interests in 2009, Apache began drilling wells and sent McDaniel, successor to the interest of Ferguson, the assignor in the 1953 assignment, a division order in which McDaniel s interest was shown as 1/16 of 3/64 of 7/8 ( %) of production from Sections 36 and 37. McDaniel, contending it was entitled to the same 1/16 of 35/64 of 7/8 ( %) of production as reserved in the 1953 assignment, notwithstanding the expiration of the burdened Cowden leases, sued Apache in 2011 for breach of contract, conversion, and an accounting. The trial court determined that since the leases included in the 1953 assignment had expired as to 32/64 out of the 35/64 aggregate mineral interest they then covered, the production payment had reduced to 1/16 of 3/64 of 7/8, i.e., 1/16 of 7/8 of the remaining 3/64 instead of 1/16 of 7/8 of the original 35/64. The El Paso court of appeals reversed the trial court s judgment, but the supreme court reversed the court of appeals and rendered judgment for Apache, holding that the trial court s judgment was correct

17 McDaniel argued that since the reservation was a fixed fraction 1/16 of 35/64 of 7/8 of production from the above described land, without any express provision for proportionate reduction if the leases did not cover (or no longer covered) a specified interest in the land, there was no basis for Apache s paying any less. The supreme court disagreed. McDaniel s interpretation, it said, incorrectly suggested the reservation of an interest unrelated to the determinable fee interests the assignor conveyed. Neither the inclusion of the four leases in a single instrument nor the instrument s statement of the leases cumulative working interest as a single fraction demonstrated that the parties intended the production payment to be carved from something other than the estates conveyed. To the contrary, according to the court, the explanatory phrase that followed the stated fraction tied the 1/16 reservation to the assignor s interest in the respective leases, indicating that the reserved interest pertained to the particular leases separately. The assignment neither stated, implied, nor suggested that the production payment would be unaffected by the termination of the leases from which it was carved, and it did not shift the production payment s burden allocable to the expired leases onto the remaining leases. Absent express language in the assignment to the contrary, the court concluded, it must apply the general rule that when an oil and gas lease terminates, the overriding royalty [or similar production payment] created in an assignment of the lease is likewise extinguished. Sunac Petroleum Corp. v. Parkes, 416 S.W.2d 798, 804 (Tex. 1967). The author s law firm is involved in this case on the side of Apache Deepwater, LLC. VII. Bona Fide Purchaser MINERAL DEED CONSTRUED AS QUITCLAIM DEPRIVING GRANTEE OF BONA FIDE PURCHASER STATUS Jackson v. Wildflower Production Co., No CV, 2016 WL (Tex. App. Amarillo Oct. 13, 2016, no pet. h.), illustrates a pitfall that is often overlooked even by experienced title examiners: reliance on a deed made or that might be construed to have been made in quitclaim form. By deed from her parents, Jane Fuller Jackson owned an undivided one-twelfth mineral interest in acres of land in Wheeler County, Texas. She and other family members executed deeds of trust in which they mortgaged their interests in the land to the First National Bank at Lubbock. When the mortgagors defaulted on the indebtedness, the property was sold at a trustee s sale to FBGA Financial Services, Inc., an affiliate of the mortgagee bank. After the foreclosure sale FBGA executed a quitclaim deed dated November 23, 1993, conveying Jane Fuller Jackson s mineral interest to Leete Jackson III, her husband. That instrument was recorded on December 3, After having executed the quitclaim deed to Leete Jackson III, but before it was recorded, FBGA executed a Mineral Deed Without Warranty to Wildflower Production Co. on November 30, 1993, which provided as follows:

18 FBGA Services, Inc.,... does hereby grant, bargain, sell, convey, transfer, assign and deliver unto [Wildflower]... a portion of the Grantor s right, title, interest, estate, and every claim and demand, both at law and in equity, in and to that part of the oil, gas and other minerals in and under and that may be produced from [the acres, among other land], being that interest previously owned by [the mortgagors, including Jane Fuller Jackson].... Jane Fuller Jackson succeeded to the interest conveyed to Leete Jackson III upon his death, and from 2002 until 2011 she received royalty payments on production attributable to her mineral interest. After a new well was drilled in 2010, a title examiner called attention to the fact that Jackson s mineral interest had purportedly been conveyed to two different grantees in Wildflower filed suit and, after a bench trial, obtained a judgment that it acquired superior title to that of Jackson, having paid value without actual or constructive notice of the deed to Leete Jackson. The court of appeals reversed the trial court and rendered judgment for Jackson, citing the Texas rule, contrary to that prevailing almost everywhere else, that a grantee under a quitclaim deed is not entitled to the status of a bona fide purchaser for value without notice of an unrecorded interest or claim. In doing so it construed the Wildflower deed to be a quitclaim, conveying only the right, title, and interest of the grantor instead of the land itself or a particular interest, notwithstanding wording that seems capable of leading to a different conclusion. The court specifically distinguished Bryan v. Thomas, 365 S.W.2d 628 (Tex. 1963), in which the court held that a deed which purports to convey all of the grantor s undivided interest in a particular tract of land, if otherwise entitled, will be accorded the protection of a bona fide purchaser, Id. at 630, largely on the basis that the deed there construed contained a warranty of title, albeit one that presumably was rendered unenforceable by the deed s granting language. Given that very many oil and gas conveyances are now drafted to convey only the grantor s right, title, and interest in land or in oil and gas leases or other interests, attorneys and land professionals should be aware of the uncertainty of the protection of the recording statutes for the grantee under such an instrument. VIII. Paying Quantities A. COURT OF APPEALS UPHOLDS JURY FINDING THAT SHUT-IN WELL WAS INCAPABLE OF PRODUCING IN PAYING QUANTITIES In BP America Production Co. v. Red Deer Resources, LLC, 466 S.W.3d 335 (Tex. App. Amarillo 2015, pet. granted), the court affirmed a trial court judgment, based on jury findings, that BP s Vera Murray lease, covering 2113 acres in Lipscomb and Hemphill Counties, Texas, had terminated. Several wells had been drilled on land covered by the lease since its execution in The last three were gas wells known as the Vera Murray Nos. 9, 10, and 11. After years of declining production from all of the wells, the No. 9 well was plugged in 2009 and the No. 10 in 2012, leaving the No. 11 well as the only producing well on the lease. The No. 11 well produced