Angela Staples
As most operators are aware, the Texas Natural Resources Code requires payment of proceeds within a specific timeframe, but it also has a “safe harbor” provision that allows operators to suspend payment of proceeds when there is a (1) dispute concerning title that affects distribution of payments; or, (2) reasonable doubt about whether the payee has clear title to the proceeds. If funds are suspended in these circumstances, the ultimate payee is not entitled to interest on the proceeds. If funds are not timely paid for other reasons, the payor must also pay interest to the payee at two percentage points above the percentage rate charged on loans to depository institutions by the New York Federal Reserve Bank. In a case argued to the Texas Supreme Court in February of this year, titled Freeport-McMoran Oil & Gas, LLC and Ovintiv USA Inc., v, 1776 Energy Partners, LLC, the propriety of an operator’s decision to suspend funds was challenged.
The decision to suspend the payment of proceeds was made because of a judgment awarded to Longview Energy Co. in a suit it brought against 1776, in which Longview claimed 1776 breached its fiduciary duties to Longview by usurping a corporate opportunity when it acquired certain oil and gas leases. These oil and gas leases were subject to several Joint Operating Agreements with FMOG, the operator. The judgment provided that Longview had an immediate equitable interest in and constructive trust over all of the interest in the leases and associated production. The judgment also ordered 1776 to assign legal title to the oil and gas interests to Longview within thirty (30) days. 1776 appealed the decision to the 4th Court of Appeals and filed a supersedeas bond with the lower court, which suspended enforcement of the judgment pending the appeal.
In light of the judgment and appeal, FMOG suspended the payment of proceeds. They reasoned that until the underlying title dispute was fully and finally adjudicated, paying either of the competing claimants could expose them to the risk of paying the wrong party.
While the appeal was pending, 1776 filed a separate lawsuit against FMOG claiming that FMOG breached the JOAs by suspending the payment of proceeds to 1776. Five years later, 1776 prevailed at the Texas Supreme Court on the title claims. Nine days after the Court’s opinion was issued, FMOG’s successor, Encana (FMOG and Encana collectively referred to as “FMOG”), released the suspended funds to 1776. In spite of this, 1776 continued to prosecute its claim that the proceeds payments were wrongfully suspended so it was owed interest and attorney’s fees. The trial court sided with FMOG.
1776 appealed the trial court’s ruling. 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 “raised a genuine issue of material fact about whether [FMOG] had a reasonable doubt that [1776] 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 Court accepted the petition for review.
FMOG’s argued to the Supreme Court that “[t]he court of appeals misinterpreted and misapplied the safe harbor statute to require (1) payors to undertake an analysis of the merits of the underlying title dispute to determine whether and to what extent the title dispute affects distribution of payments; and (2) a fact finding to determine whether the payor’s doubt that the payee ‘has clear title to the interest in the proceedings of production’ was reasonable.” FMOG claimed that the appellate court “relied on the final phrase of subsection (b)(1)(A)—‘that would affect the distribution of production proceeds’—to infer the safe harbor protections do not apply if the payor could have paid the proceeds to one of the competing claimants.” FMOG argued that such a holding did not comport with the plain language of the statute, which does not require a payor to “analyze the legal and equitable rights of the competing claimants and make a risky decision about which claimant to pay.”
1776 countered that no legitimate dispute concerning title existed because they continued to hold legal title (having never transferred the interests to Longview because they stayed the enforcement of the trial court’s judgment by filing a supersedeas bond). 1776 also claimed that FMOG’s doubts regarding title to the interest were not reasonable, as is required by the safe harbor provisions.
For operators who suspend funds while awaiting the outcome of a suit between competing claimants to an interest, this is an extremely compelling case. FMOG pointed to the risk of being exposed to double payment of proceeds if it had paid the party who ultimately lost, and the losing party could not or would not pay the proceeds over to the prevailing party. In my opinion, that is just what the safe harbor provision seeks to avoid. But if operators have 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), can it really be called a safe harbor at all?