Angela Staples
I previously wrote about a case pending opinion in the Texas Supreme Court—Freeport-McMoran Oil & Gas, LLC and Ovintiv USA Inc., v, 1776 Energy Partners, LLC. Recently, the Court issued an opinion which should have operators letting out their collectively held breaths. To recap, the suit was originally brought by 1776 Energy Partners, LLC, against Freeport-McMoran Oil & Gas, LLC and Ovintiv USA Inc. (collectively referred to as “FMOG”). FMOG suspended the payment of proceeds to 1776 Energy when a judgment was awarded to Longview Energy Co. in a suit it brought against 1776 Energy, in which Longview claimed 1776 Energy breached its fiduciary duties to Longview by usurping a corporate opportunity when it acquired certain oil and gas leases. 1776 Energy appealed and, while the appeal was pending, also filed a separate lawsuit against FMOG claiming that FMOG breached the JOAs by suspending the payment of proceeds to 1776 Energy.
Ultimately, 1776 Energy prevailed at the Texas Supreme Court in the Longview suit. FMOG released the suspended funds to 1776 Energy nine days after the Court’s opinion was issued. In spite of this, 1776 Energy continued to prosecute its claim that the proceeds payments were wrongfully suspended. 1776 Energy claimed that because of the wrongful suspension, it was owed interest and attorney’s fees.
FMOG, relying on the Texas Natural Resources Code’s “safe harbor” provision, argued that it was allowed to suspend payment of proceeds because there was a (1) dispute concerning title that affects distribution of payments; and, (2) reasonable doubt about whether the payee has clear title to the proceeds. FMOG claimed that, in light of the judgment and appeal, the suspension of the payment of proceeds was proper until the underlying title dispute was fully and finally adjudicated. Indeed, paying either of the competing claimants could expose them to the risk of paying the wrong party. The trial court agreed with FMOG and ordered that 1776 Energy take nothing.
1776 Energy appealed and the court of appeals reversed the trial court, holding that FMOG did not “establish, as a matter of law, that the title dispute reflected in the Longview Judgment affected the distribution of payments.” The court of appeals also held that 1776 Energy “raised a genuine issue of material fact about whether [FMOG] had a reasonable doubt that [1776 Energy] had clear title to the production proceeds.” FMOG filed a petition for review with the Texas Supreme Court, asking the Court to review the court of appeal’s decision.
The Texas Supreme Court noted that both 1776 Energy and the court of appeals misconstrued the first safe harbor provision. Specifically, the Court found that the “provision requires that the dispute existing between 1776 Energy and Longview when [FMOG] withheld the payments ‘would affect’ distribution of the production payments.” The Court looked to a number of sources and determined that “would” was used in its auxiliary form (i.e. requiring a main verb to follow). Thus, its meaning was intended to “express ‘a contingency or possibility.’ “Affect,” being the main verb following “would,” meant “‘to produce an effect upon.’” Therefore, the Court stated that “[t]he inclusion of ‘would’ as an auxiliary verb with ‘affect’ as a predicate verb alters the sentence’s meaning so that, instead of requiring a ‘current effect,’ the provision requires only an expected future effect.” Therefore, the first section of the safe harbor provision “permitted [FMOG] to withhold the payments without interest if the dispute concerning title was, at that time, at least expected or likely to influence or alter the distribution of the payments [FMOG] owed to 1776 Energy under the joint-operating agreements. In our view, as a matter of law, it ‘would.’”
The parties next argued about whether the second safe-harbor provision applied. That provision allows suspension of proceeds if an operator has a reasonable doubt that the payee has clear title to the interest in the proceeds of production. 1776 Energy argued that the trial court erred in granting FMOG’s summary judgment because “reasonableness must be resolved by a factfinder as a question of fact rather than by a court as a matter of law.” The Court disagreed, stating that
[r]easonableness has always entailed an objective inquiry. […] While questions of reasonableness must be submitted to a factfinder when a genuine disagreement about the facts prevents the law from generating an objective answer, no case citing that proposition can be understood to say that a factfinder must resolve all issues touching on reasonableness. […] As a result, when the material facts are undisputed and lead to but one rational conclusion, courts may resolve section 91.402(b)(1)(B)(ii)’s “reasonable doubt” prong as a matter of law. Applying that prong here, we hold as a matter of law that [FMOG] had a “reasonable doubt” that 1776 Energy had “clear title to the interest in the proceeds of production.”
Operators can now feel certain that, in the appropriate circumstances, they can suspend payment of proceeds rather than having to choose between paying funds to the initial prevailing party—without the dispute being fully and finally adjudicated—and risk a double payment, or suspending the funds and risk exposure to potentially years of interest on the proceeds and attorney’s fees (paid out of its own pocket). This is exactly the safety the safe harbor was meant to provide.