Replies to This Discussion

Permalink Reply by Bobi Carr ("parker") on January 6, 2009 at 15:31

Oil and Gas Lease and Division Order Conflicts


By Kathleen Dotzel Knight, Attorney

With the boom in natural gas wells, you can bet there will be as big a boom in oil and gas litigation. One area where increased litigation is expected is in disputes over the payment of royalties resulting from conflicts between the oil and gas lease and the division order. Because division orders are not issued until there is actual production, mineral owners and operators sometimes forget to address the particulars of division orders when negotiating a lease. This is a mistake.
Division orders are revocable contracts directing the distribution of proceeds from the sale of oil and gas.[i] Using a title opinion as a basis, division orders set out the fraction of production each party is entitled to receive. Each interest owner will be asked to sign the division order before the first royalty check is issued. Sometimes the division order contains terms that are either not in the lease agreement or are different than the lease agreement and can be less favorable to the owner. The owner should carefully review a division order before signing it. If the owner signs the division order, it is a binding agreement and, while in effect, will take precedence over the lease.
If the owner refuses to sign the order, the operator may withhold royalties. In an attempt to avoid conflicts this situation creates, Texas passed a law that provides that a payee may be required to sign a division order as a condition to receiving payment if the payor 1) uses a form that contains only certain listed provisions or 2) uses the model division form set out in the statute.[ii] The producer cannot withhold royalty payment solely on the basis of an owner’s refusal to sign a division order that is not in compliance with this statute.[iii]
Although this law has provided some stability, open issues persist. While it states that a division order can never permanently amend or supplant a lease, case law exists that holds that the division order will control while in effect.[iv] Also, even though the law specifically states that any provision in the order that is contradictory to the lease is invalid to the extent of the contradiction, it then allows that the order may be used to “clarify royalty settlement terms.”[v] So this leaves open to interpretation when something would be considered “contradictory” vs. supplemental or clarifying.
The statute confuses things even more when it defines “market value,” “market price,” “prevailing price in the field”or other such language when used as the basis of a valuation in the lease as "the amount realized at the mouth of the well by the seller of such production in an arms length transaction." The problem is that this definition is contra to Texas case law which consistently maintains that these terms are not the same. “Proceeds” or “amount realized” requires the royalty to be measured based on the amount actually received by lessee. By contrast a “market value” or “market price” clause bases royalties on the prevailing market price for gas irrespective of the actual sales price.[vi] So a division order, if interpreted in accordance with this statute, may well alter the valuation method agreed to in the lease.
Because of the ambiguity surrounding these issues, it would be wise to sort out these matters when negotiating the lease. At a minimum the lease should provide that 1) any division order issued will not change the royalty valuation method defined in the lease, and 2) that the signing of a division order that in any way alters the terms of the lease will not control nor temporarily amend the original lease.
If careful attention is given to setting out details of division orders at the lease drafting stage and the owner does a careful review of the division order before signing, these disputes can be avoided.

Kathleen Dotzel Knight is a partner with Whitaker, Chalk, Swindle, & Sawyer L.L.P. in Fort Worth. She specializes in litigation, dispute management, and major strategic transactions. For more information, contact her at 817-878-0595 or kknight@whitakerchalk.com.



--------------------------------------------------------------------------------

[i] See Texas Natural Resource Code Section 91.401.
[ii] However, see Coastal Oil & Gas v. Roberts, 28 S.W.3d 759 (2000) where the court held that the model form is only applicable to oil production, not gas.
[iii] See Texas Natural Resource Code Sections 91.402.
[iv] See Sections 91.402(g) and (h) of the Texas Natural Resource Code; Exxon v. Middleton, 613 S.W.2d 240 (Tex. 1981); Chesapeake Operating Inc v. Bond, 201 S.W.3d 369(Tex. 2006), and Judon Fambrough, “Mineral Rights, Surface Rights and Royalty Payments” @ http://recenter.tamu.edu.
[v] See Texas Natural Resource Code Section 91.402(i).
[vi] See Yzaguirre v. KCS Resources, 53 S.W.3d 368 (Tex. 2001); Bowden v. Phillips Petroleum Company, 247 S.W.3d 690 (Tex. 2008).

• ▶ Reply

Permalink Reply by DaddyT on January 6, 2009 at 16:13

This property is in Louisiana, Caddo Parish.

• ▶ Reply

Permalink Reply by Bobi Carr ("parker") on January 6, 2009 at 16:24

I remember reading that a DO was not required in Louisiana.

My experience has been the same as Gosh Darn's. I used to get DO regularly. Then I began to receive payments on wells where I didn't sign a DO.

I just ran across this article when I was searching the web trying to find information about DOs.I thought it was interesting and might give information for Texas residents.

DaddyT's post sparked my curiousity.

• ▶ Reply