WHAT CAN I DO IF MY ROYALTIES ARE NOT BEING PAID?

JOHN B.MCFARLAND
GRAVES DOUGHERTY HEARON &MOODY
401 CONGRESS, SUITE 2200
AUSTIN, TEXAS 78703
512-480-5618
jmcfarland@gdhm.com
www.oilandgaslawyerblog.com

Introduction

This paper is intended to give general guidance to royalty owners who believe that they
are owed royalties but are not receiving payment. It is not intended as legal advice, and royalty
owners are encouraged to consult with their own legal counsel regarding their particular
situations.

In order to enforce your rights as a royalty owner, it is necessary first that you understand
how exploration companies pay their royalties.

Before a well is drilled, an exploration company obtains oil and gas leases covering the
lands on which the well will be located. This may be as simple as obtaining one oil and gas lease
from the single mineral owner of the tract, or it may involve obtaining multiple oil and gas leases
from many mineral owners of several tracts. If the tracts are small, it may also require that the
tracts be pooled together into a single pooled unit for drilling of the well. The company then
obtains a "drilling title opinion" on the tract or unit where the well will be located. This is an
opinion from a title attorney who has reviewed all of the recorded documents concerning the
mineral title to the lands in question, stating the ownership of the mineral and leasehold estate.
Its purpose is to assure the exploration company that the company has an oil and gas lease or
leases covering all of the mineral interests in the tract or unit where the well will be drilled.
After the well is drilled and completed, the exploration company must determine how
royalties should be paid on production. The company will then obtain a "division order title
opinion," usually from the same attorney who did the drilling title opinion for the well. The
purpose of the division order title opinion is to ascertain the ownership of royalties on production
from the well. Again, this may be very simple, if there is only one royalty owner. Usually,
however, there are multiple royalty owners. Royalty ownership may be different from mineral
ownership.

Most title opinions make "requirements" for "title curative" steps that should be taken,
based on the attorney's title examination. These could involve obtaining copies of probate
records on the estate of a royalty owner who has died, or affidavits of facts necessary to ascertain
ownership, such as family histories. Some documents in the title may be susceptible to more
than one interpretation, and the title attorney may make a requirement that the parties execute a
stipulation as to the meaning of the ambiguous instrument. Where a well has been drilled on a
pooled unit, a common requirement is that the company obtain ratification of the pooled unit by
royalty owners. Requirements can address myriad issues.

It is then the job of the land department of the exploration company to (1) obtain the
documents necessary to satisfy the requirements in the division order title opinion and (2)
prepare division orders (reflecting the royalty ownership shown in the title opinion) to send out
to the royalty owners. A division order is a document that identifies the property and the royalty
owner's interest. The royalty owner must sign and return a proper division order to confirm that
he/she agrees that his/her interest is correct, and must provide an address for payment and his/her
social security or taxpayer I.D. number for IRS purposes. Once the division order is returned,
the company then sets up its "pay deck" for payment of royalties in its royalty payment system
and places the royalty owner in line for payment.

Most royalties are paid by the operator of the well; the operator sells the production to oil
and/or gas purchasers, collects 100% of the proceeds of sale, and disburses the royalty to the
royalty owners in the well. Some purchasers of oil also agree to disburse oil royalties directly to
the royalty owners as a part of their agreement with the operator. If a well produces both oil and
gas, a royalty owner may therefore receive checks from two different companies – from the
operator for gas production and from the oil purchaser for oil production. In some instances
there may be multiple owners in the well who elect to separately sell their share of the
production, and in such a case each owner may separately pay royalties on its share of
production from the well. In those cases a royalty owner might receive production royalties on
the same well from two different companies for oil or gas or both.

Depending on the complexity of the royalty title, it may take the operator several months
after a well commences production to get the division order title opinion, perform the necessary
curative work, and send out division orders, so that royalty payments can commence. Once
payments have begun, royalties on oil production should be paid by the end of the month
following the month in which production occurs, and royalties on gas production should be paid
within two months after the end of the month in which production occurs. The payor, whether
the purchaser or the operator, is required to provide with the payment certain information
concerning the amount of production, the price for which it was sold, and any deductions being
made from the payment.

Division Orders

In Texas, the party responsible for payment of royalties (the "Payor"), whether the
operator or the oil purchaser, is entitled to receive a signed division order from a royalty owner
before paying the royalty. This requirement is set forth in Chapter 91 of the Texas Natural
Resources Code, known as the royalty payment statute. The statute sets forth the time within
which royalties must be paid, the terms the Payor can require in division orders, and remedies for
the royalty owner who is not timely paid. Section 91.402 provides that (1) royalties must
commence to be paid "on or before 120 days after the end of the month of first sale of production
from the well," and (2) thereafter, royalties on oil must be paid within 60 days after the end of
the month in which production is sold, and royalties on gas must be paid within 90 days after the
end of the month in which the gas is sold. These time limits may be modified by provisions in
the oil and gas lease pursuant to which royalties are owed. If royalties are not paid by those due
dates, the payor owes interest on unpaid royalties at the rate of 2% over the New York Federal
Reserve Bank rate charged on loans to depository institutions. §91.403. The Payor may also be
required to pay the royalty owner's legal fees incurred in collecting the royalty due. §91.406.

The royalty payment statute also provides excuses for non-payment of royalty. The
Payor need not pay if the royalty owner has not returned a signed division order, or if there is a
"reasonable doubt that the [royalty owner] … has clear title to the interest," or if "a requirement
in a title opinion that places in issue the title, identity, or whereabouts of the [royalty owner] …
that has not been satisfied by the [royalty owner] after a reasonable request for curative
information has been made by the payor."

In order for a Payor to refuse payment for failure to return a division order, the Payor
must have sent a division order to the royalty owner, and the division order can contain only
those provisions authorized by the royalty payment statute. In general, a division order cannot
include terms that purport to modify the payment terms of the applicable oil and gas lease.
If you believe you are entitled to royalties you are not being paid, you should answer the
following questions:

1. Is there a producing well on property in which you have a royalty interest? The
operator's name must be posted at the well, along with its Railroad Commission operator
number. The operator must be registered with the Railroad Commission, and you can
look up the address and phone number for the operator on the Railroad Commission's
web site at http://www.rrc.state.tx.us/data/operators/ogdirectory/index.php. You can also
research what production for the well has been reported by the operator to the Railroad
Commission, at http://www.rrc.state.tx.us/data/online/index.php. Learn how to use the
Railroad Commission's database to look up your wells.
2. Who is responsible for payment of the royalty? Contact the operator and ask why
you have not been receiving royalties. Has the operator delegated royalty payment
responsibilities to the purchaser of production? Who is the purchaser? Has the operator
or purchaser changed recently? You can also ascertain who is purchasing the well's
production from the Railroad Commission website.
3. Does the Payor have a division order signed by you? If the operator or purchaser has
changed recently, does the new Payor require a new division order from you?
4. Under the royalty payment statute, a Payor need not pay royalties until the accrued
royalty owed is at least $100. Ask the operator how much has accrued for your account.
5. Ask the operator if there are title curative requirements that must be satisfied before
you can be paid. If so, ask for a copy of the title requirement.

When you talk to the companies, take notes on your calls. Write down the names and ask
for the direct numbers of the people you talk to, and ask them when they will call you
back to answer your questions. Follow up, and be persistent.


Title Problems

If your royalty is not being paid because of a title problem or requirement, ascertain what
you need to do to solve the problem. It may be as simple as providing an affidavit of relevant
facts. The landman with the operator should be able to help you with this. If the problem is
more complicated, it may be necessary to consult with an attorney to determine how the problem
can be solved. Resolving the issue may require the filing of a suit.

If you are being asked to sign a lease or pooled unit ratification before being paid your
royalty, beware. Signing the ratification may not be in your best interest, and the company may
owe you royalties whether you sign the ratification or not. Consult with legal counsel before
signing a ratification.

When a Payor is not paying royalties because of a potential title dispute or a title curative
requirement, it is said that the royalty is placed "in suspense," or in a "suspense account." This
term can be misleading. It does not mean that the Payor opens a separate bank account and
deposits the money into the account. A suspense account is simply an internal account of the
company that shows the amount as a liability of the company for an unpaid royalty. If funds
placed in suspense are not claimed by the owner, under Texas escheat statutes the Payor must
pay the monies to the Texas Comptroller's Office, into its Unclaimed Property Fund. The owner
may claim the money from the Comptroller upon satisfactory proof of ownership.
http://www.window.state.tx.us/up/

If the title problem is one of ascertaining to whom the royalty should be due, the Payor is
a disinterested stakeholder. In other words, the Payor does not dispute that it owes the money to
someone, but it faces potential conflicting claims to the funds. In such a circumstance, the Payor
may elect to file what is known as an Interpleader action to determine the proper owner (or might
be encouraged to do so). In an Interpleader, the stakeholder sues the parties who are asserting
conflicting claims to the royalties due and deposits the royalties into the court. The Payor is then
out of the case, and the claimants resolve their claims between themselves.
Remedies
If you have determined that oil or gas is being produced on which you should be paid
royalty, and you have signed and returned a division order showing your interest, and there are
no title problems preventing payment, then you have a cause of action against the Payor for
failure to pay your royalty. Chapter 91 of the Natural Resources Code provides that a royalty
owner may collect from the Payor the amount due, plus interest, plus attorneys' fees. If your
royalty payment is due under an oil and gas lease you signed, you also have a claim against the
lessee for breach of the oil and gas lease, entitling you to collect the amount due plus interest and
attorneys' fees. Before bringing such a claim, you must give 30 days' written notice by mail of
the Payor's failure to pay you. If the Payor does not respond within 30 days with a reasonable
cause for nonpayment, you may sue the Payor in the county where the well is located.

If the operator is the party responsible for payment, you may also wish to notify the
company or companies purchasing the well's production of the operator's failure to pay and
demand that the purchaser pay your share of production proceeds to you directly. This is not
likely to get you paid, but it may cause the purchaser to withhold payment to the operator of your
share of proceeds, thus "trapping" the money with the purchaser. If the operator is potentially
insolvent, this may be a good way to preserve your right to payment without having to fight with
the operator's other creditors in the bankruptcy court. As discussed below, Texas Business &
Commerce Code §9.343 grants you a security interest in proceeds of sale of production to secure
the operator's obligation to pay you. You should assert your rights under this statute when you
notify the operator's purchaser of your claim.

Finally, if the facts show that your operator/lessee is simply pocketing your royalties, you
may be able to obtain assistance from your local district attorney. The operator's failure to pay
you may be a crime for which the operator could be prosecuted. The prosecutor would have to
show that the operator has taken and used the royalty funds as his own and intentionally deprived
you of your royalties with no legitimate excuse.
Payor's Insolvency

In the 1980's oil prices declined to record lows and some companies sought protection
from creditors by filing for bankruptcy. Royalty owners found that, if the bankrupt company
owed them royalties, they were classified as unsecured creditors and had to fight with other
unsecured creditors of the company over limited funds (if any) to recover their royalties. As a
result, the Texas Legislature passed a new statute, now Section 9.343 of the Texas Business and
Commerce Code, which grants to royalty owners a security interest in production from their
well, and in the proceeds of sale of production, to secure the payment of their royalties. Royalty
owners do not have to make any filings or do anything in advance in order to have the
protections of this statute. Its effect is to make the royalty owners secured creditors in the
bankruptcy case of the company that owes them royalties. If the company still has funds in its
account that represent proceeds from the sale of production, you would have a claim against
those funds superior to unsecured creditors of the company. The statute has been upheld and
enforced in bankruptcy proceedings.

If the company that pays your royalties files for bankruptcy, you will receive a notice of
that filing, as a creditor of the company. Typically, the notice will classify you as an unsecured
creditor. In order to take advantage of the protection provided by Section 9.343, you will have to
file a claim asserting your secured status. This will probably require the help of a bankruptcy
attorney.

If you receive royalties from the purchaser rather than the operator, and if the purchaser
enters into bankruptcy, you should claim that your lessee/operator still owes you the royalties
due. In other words, the fact that you agreed to accept payment of your royalties from the
lessee's purchaser should not relieve the lessee of the obligation to pay royalties if the purchaser
fails to do so.