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Permalink Reply by Skip Peel - Mineral Consultant on September 12, 2014 at 2:34

Unitization Victory for E&P Companies at Louisiana Supreme Court

By Paul Simon on August 26, 2014 Gordon Arata Law Firm Newsletter

Yesterday, the Louisiana oil and gas industry achieved a major victory with the Louisiana Supreme Court’s ruling in Gatti et al. v. State of Louisiana, et al., No. 2014-C-863 (consolidated).

Gatti was a purported class action lawsuit by a group of north Louisiana landowners who challenged the regime of “unitization”–Louisiana’s term for forced pooling–established by the Louisiana Office of Conservation in the Haynesville shale.  The landowners sued the State, through the Office and Commissioner of Conservation, and practically every exploration and production company currently operating a “unit” well in north Louisiana.  The landowners contended that the units established in the Haynesville and other formations were invalid and should be retroactively dissolved.  They alleged that the leases purportedly held by production from these units should be canceled and that the past payments made in reliance on those units should be recalculated.

In a well-reasoned opinion, Judge Morvant of the 19^th Judicial District Court in Baton Rouge ruled in favor of the State and E&P companies and dismissed all of the landowners’ claims on various grounds.  Essentially, Judge Morvant viewed the plaintiffs’ claims to be an improper end-run around well-established and exclusive administrative procedures for challenging unit orders of the Commissioner of Conservation.  However, the Louisiana First Circuit Court of Appeal reversed, reinstating the landowners’ claims and allowing the suit to go forward as pled.

The State and E&P companies applied to the Louisiana Supreme Court for writs.  The Supreme Court granted these writs.  More importantly, the Court also–without requiring further argument–entered a per curiam order reversing the First Circuit, reinstating the district court’s ruling and dismissing the landowners’ claims “as originally ordered by the district court.”

The Supreme Court’s decision was a major victory for the O&G industry, and the correct legal result.  Louisiana’s unitization process is legislatively established, comprehensive and administered by the Office of Conservation.  Under it, a unit is created by the Commissioner of Conservation only after public notice and a contradictory hearing.  At the hearing, which is open to the public and in which landowners can and often do participate, geological and engineering evidence in support of the unit is submitted.  A unit is created only if the Commissioner, in consultation with his staff of expert geologists and engineers, determines based on that evidence that a unit is warranted.  In that case, the Commissioner issues an order establishing the unit and providing factual findings supporting his determination.

This process has successfully regulated the development of Louisiana’s mineral resources for over 50 years.  E&P companies and landowners alike have benefited from it, including from the large sums invested, and paid to landowners, in reliance on the Commissioner’s orders.  To protect the finality and integrity of these orders, the Legislature included various procedural protections in the regime.  These procedural protections are essentially the same as any other administrative scheme and include requirements for the exhaustion of remedies and an exclusive mechanism–with mandatory time periods and evidentiary requirements for the submission of the administrative record–to appeal or challenge the Commissioner’s orders.

The landowners’ suit was an all-out assault on this regime.  The landowners had not participated in the administrative proceedings whose results they attempted to challenge, and their suit did not comply with the requirements for bringing such a challenge.  More pointedly, their suit challenged the factual findings of the Commissioner regarding the propriety of the units he had established.  It attempted to nullify over 800 unit orders en masse, without reference to the administrative record supporting each unit, and as a suit before a district judge who lacked the Commissioner’s expertise and expert staff and, respectfully, was neither equipped nor authorized to hear these challenges de novo.

In dismissing the landowners’ suit, the district court recognized these deficiencies.  The Supreme Court likewise affirmed the integrity of the administrative process by reversing the First Circuit and reinstating the district court’s decision.

Gordon Arata attorneys, including Bob Duplantis and Paul B. Simon from our Lafayette office and Scott O’Connor from our New Orleans office, collaborated with counsel for the State and E&P companies in defending the suit and preparing the writ applications granted by the Louisiana Supreme Court.  If you have any questions about this suit, or Louisiana unitization or litigation issues more generally, please do not hesitate to contact them.

Permalink Reply by J. T. Boswell on January 22, 2014 at 6:04

Texas has instituted a "horizontal well production royalty percentage" based on the length of horizontal under your property (and/or within the "frac zone") regardless of exiting leases. This was deemed necessary and instituted by the RRC because of the many small acreage leases that already existed. Recent development in the Woodbine in Madison Co. is an example. Maybe Louisiana should consider something like this as an addendum to the existing "section" units (some "units" are 1.5 sections in west Sabine Parish). This could be used to provide additional revenue for those directly depleted (within the horizontal frac zone) while still providing revenue for those in the previously established units.  

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Permalink Reply by Skip Peel - Mineral Consultant on January 22, 2014 at 6:19

J. T., can you post the Texas regs?  Here in LA it's not about leases, it's about units and how they are formed with regard to drainage footprint per well.  It is highly doubtful that the court would nullify what the Commissioner has approved to date.  However the case may be helpful in bringing about a wider discussion of how current regs and codes are ill-suited to E&P in the age of horizontal development.  Legislative code reform would be the best course but that's a steep hill to climb.  This business of making piecemeal interpretations through court rulings is a poor substitute.  The current LA mechanism for assigning production to royalty interests when a perforated lateral includes more than one unit is by linear foot of perforated lateral lying within each unit boundary.  The Texas system sounds similar.

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Permalink Reply by J. T. Boswell on January 22, 2014 at 8:13

I don't have the specific RRC edict but the agreement is called a "Production Sharing Agreement" (similar to what you describe for LA.), and takes into consideration small "units" (not leases) (as small as 40 acres) that are fairly common for verticals in the Woodbine Sandstone, and other formations. So now with horizontal bores capable of extending virtually a mile from the vertical borehole many of these "units" can be transected, and apparently redefining the "unit" per depth of the horizontal is untenable.

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Permalink Reply by dbob on January 22, 2014 at 9:01

Those PSA's are still getting a disclaimer from the RRC  "Commission Staff expresses no opinion as to whether a 100% ownership interest in each of the leases alone or in combination with a "production sharing agreement" confers the right to drill across lease/unit lines or whether a pooling agreement is also required. However, until that issue is directly addressed and ruled upon by a Texas court of competent jurisdiction it appears that a 100% interest in each of the leases and a production sharing agreement constitute a sufficient colorable claim to the right to drill a horizontal well as proposed to authorize the removal of the regulatory bar and the issuance of a drilling permit by the Commission, assuming the proposed well is in compliance with all other relevant Commission requirements. Issuance of the permit is not an endorsement or approval of the applicant's stated method of allocating production proceeds among component leases or units. All production must be reported to the Commission as production from the lease or pooled unit on which the wellhead is located and reported production volume must be determined by actual measurement of hydrocarbon volumes prior to leaving that tract and may not be based on allocation or estimation. Payment of royalties is a contractual matter between the lessor and lessee. Interpreting the leases and determining whether the proposed proceeds allocation comports with the relevant leases is not a matter within Commission jurisdiction but a matter for the parties to the lease and, if necessary, a Texas court of competent jurisdiction. The foregoing statements are not, and should not be construed as, a final opinion or decision of the Railroad Commission."

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Permalink Reply by Skip Peel - Mineral Consultant on January 22, 2014 at 9:13

Thanks, J.T. and dbob.  Nice bureaucratic tap dance that.  Any idea if there is currently any litigation on the subject?

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Permalink Reply by J. T. Boswell on January 22, 2014 at 10:45

As I understand it, the allocation formula for the horizontal bore was developed/provided/approved by the RRC. Approval or acquiescence, just a matter of semantics here in Texas, until court challenged. The PSA, and the directional drilling could certainly be used to gerrymander small property owners either in or out depending on the whim (possibly past experience with royalty and land owners) of the driller/drilling permit holder (not withstanding the geology).

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Permalink Reply by Thomas C. McKowen, IV on January 22, 2014 at 11:17

Am I correct in understanding that there would only be a  need for such allocation if the borehole crossed a unit line?  In other words, if a horizontal well has a borehole totally within an existing unit, the allocation would be the same as on existing Division Orders for vertical wells in the unit.

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Permalink Reply by Skip Peel - Mineral Consultant on January 22, 2014 at 11:25

Only when the perforated lateral crosses from one unit to another adjacent.  Allocation of royalty within a unit is the same for a vertical or horizontal well.  Keep in mind that a unit not only has a surface footprint with boundaries but also a depth definition.  A tract may be included in multiple units based on formation and depth.  It is possible to have varying decimal interests based on the unit size.  A tract may be in a 640 acre unit for one formation and also in a 320 acre unit for a different formation.

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