Timing is Everything

Timing is everything. In January of this year, a petition for review was filed with the Texas Supreme Court titled Scout Energy Management, LLC v. Taylor Properties, in which Scout asks the Court overturn an opinion issued out of the 7^th Court of Appeals in Amarillo that involved the interpretation of a shut-in royalty clause of a lease and how to credit payments made under that clause. The ultimate holding of the court of appeals rested on a notation made on one of the shut-in royalty payment checks, rather than any lease language.

The lease in question provides that if gas is not being produced “Lessee may pay as royalty $50.00 per well per year, and upon such payment it will be considered that gas is being produced […]” Actual production on the lease stopped in September 2017. Scout’s predecessor paid the shut-in royalty payments on September 6, 2017. They also paid a second shut-in royalty payment on October 10, 2017, thirty-four days later. After Scout acquired the lease, it paid a shut-in royalty payment on December 21, 2018. Actual production resumed in November 2019.

Taylor, the lessor, argued that the lease terminated in October 2018, which is one year after the second shut-in royalty payment was made. Scout maintained that the three shut-in royalty payments “were timely under the clause and served as constructive production for at least a three-year period.” The trial court found that the shut-in royalty clause was ambiguous and “concluded that 1) the second royalty payment of ConocoPhillips extended the shut-in royalty period for an additional twelve months and 2) Scout’s payment of a third royalty on December 18, 2018, extended the period through the time by which production resumed.”

Taylor appealed, insisting that the time period of constructive production “run[s] one year from the time of the most recent payment made pursuant to that clause. In effect, Taylor would read the clause as providing, ‘upon such payment it will be considered that gas is being produced for one year from the date of payment or until another payment is tendered.’” The Court of Appeals disagreed, finding that “the more reasonable understanding given the plain language of the phrase and in light of contract construction principles is that ‘upon such payment’ [meant] ‘After lessee pays $50.00 per well per year, the well will be considered producing for that year.’”

Of course, the Court of Appeals pointed out, the shut-in royalty payments may certainly be made in advance.

The Court of Appeals continued by noting that “the anniversary for tendering the next shut-in royalty payment is that which the parties may designate on the form of payment (e.g., check) or the receipt memorializing payment.” Here, they acknowledged that the September 2017 payment set the shut-in royalty anniversary date at September 6, 2017, because the check “had written on it ‘9-06-17’ under the heading ‘Mth Begin.’ […] [T]hat set the starting date of the shut-in royalty period at September 6, 2017, and the anniversary date one year later, i.e., September 6, 2018.”

Unfortunately, the second check for shut-in royalty had “10-09-2017” under the heading “Mth Begin.” The Court of Appeals held that it was obligated, by various authorities, “to interpret the notation on the second receipt as [lessee]’s decision to establish a shut-in royalty period differing from that set by the September 6th payment. The new period was one month longer than the first.” When no shut-in royalty payment was made on or before October 9, 2018, the lease terminated.