TXO v. Vela Remembered in a Gas Royalty Case

Originally published by Charles Sartain.

Posted by Charles Sartain

Westport Oil & Gas Company, L.P. v. Mecom et al. presented this question: Was the lease royalty based on a gas purchase agreement formula or on the royalty clauses’s market value at the well provision?

Spoiler alert: Invoking the seminal Texas Supreme Court decision in Texas Oil and Gas Corporation v. Vela, the court went with market value at the well.

Dueling paragraphs

Under Paragraph 3, the royalty clause, gas royalty was 42 percent (not a typo!) of the “market value at the well … “.

Paragraph 17 said: “Notwithstanding any other provision of this lease to the contrary … a contract for the sale of gas … shall provide for the sale price computed on the average of the highest price paid by three separate Intrastate Purchasers of gas of like quality and quantity in [RRC] District 4 …”.

The court instructed the jury to compute the gas royalty’s market value based on Paragraph 17. The jury found that Kerr McGee failed to pay those royalties and awarded millions in damages and attorney fees.

The Court’s analysis

Mecom argued the significance of “Notwithstanding any other provision” language. Ignoring Paragraph 17, requiring that the three highest prices become the formula to calculate the market value, renders the paragraph meaningless.

Kerr McGee argued that the Paragraph 17 formula pertained only to future gas purchase agreements and did not alter the commonly accepted meaning of “market value at the well” as stated in Paragraph 3.

The court concluded that the royalty provision is not “contrary” to the gas purchase agreement provision and did not elevate Paragraph 17’s price mandate over Paragraph 3’s market value provision. Paragraph 3 defined the royalty owed and Paragraph 17 set a minimum contract price for future gas purchase agreements. Nothing more.

Remembering Vela

In that case the working interest owners sold gas at a price fixed by a gas sales contract. The market value of gas at the wellhead rose to be far in excess of the gas contract price.  The lease specified the royalty would be “1/8^th of the market value … ”. The royalty owed was determined from the royalty provision, which was wholly independent of the gas contract. The court declined to conflate the gas contract price with the market value requirement. Victory for the royalty owner.

… and Yzaguirre

Bastard child of Vela (if you are a royalty owner). This time the market value measure worked for the lessee. The gas purchase price was far in excess of the market value.

What did we learn?

• The lease dated to 1974. As with Godzilla, leaky shower pans, and the flea flicker in the fourth quarter, dangerous situations can lie dormant for a long time, bringing misery when the victim least expects it.
• Despite the lessors’ best efforts to protect themselves, the case turned on one short phrase in a comprehensive, three-page royalty clause.
• “Notwithstanding anything to the contrary … ” is a favored device for scriveners. Make sure it addresses that which you are trying to protect. What if Paragraph 17 had addressed the market value clause directly?

Merry Christmas.

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