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L.B. Hailey Family Limited Partnership v. Encana Oil & Gas (USA) Inc.

United States District Court, W.D. Texas

June 27, 2018

L.B. Hailey Limited Partnership Plaintiff,
Encana Oil & Gas USA Inc. Defendant.


          Royce C. Lamberth United States District Judge.

         Before the Court is Defendant Encana Oil & Gas (USA) Inc.'s ("Encana") Motion to Dismiss Plaintiff L.B. Hailey Family Limited Partnership's ("LBH") Complaint on the grounds that LBH failed to state a claim upon which relief could be granted. Fed.R.Civ.P. 12(b)(6). For the reasons below, the Court GRANTS Encana's motion to dismiss with respect to LBH's causes of action for breach of contract and violation of the Texas Natural Resources Code, as well as its declaratory judgment cause of action; and DENIES Encana's motion to dismiss with respect to LBH's causes of action for breach of contract related to accounting and LBH's claim to attorney's fees. Because LBH's amended complaint was considered in this opinion, LBH's motion for leave is GRANTED; LBH's motion to continue on response is DENIED as moot.

         I. Background

         This case involves two nearly identical leases covering land in Karnes County, Texas. The leases differ only in that one requires a twenty-percent royalty, whereas the other has been amended to provide a twenty-five percent royalty. LBH is the lessor. Through a sequence of assignments, Encana became the lessee in 2014. Producing wells were drilled and completed by both a predecessor-in-interest and Encana between 2011 and 2016.

         Encana is the current operator of the leaseholds and the wells on this land. LBH requested in March 2016 that Encana provide an accounting of production from the wells and the royalties and expenses associated with that production. LBH also requested that Encana stop deducting post-production expenses from LBH's royalty payments. LBH repeated its requests in June of 2016, and Encana replied shortly thereafter that while it disagreed with LBH's assertions, it would no longer deduct a processing fee or processing fuel charge. LBH sent two subsequent letters demanding that all deductions other than taxes cease. Encana reiterated its disagreement with LBH on the matter and stated it would not stop deducting post-production costs.

         LBH filed suit against Encana in state court, alleging that Encana improperly deducted post-production expenses from LBH's royalty payments and that, despite LBH's complaints, the practiced has continued to happen. ECF No. 1, at 13. LBH claims these post-production costs deductions breach the lease agreements and violate Texas Natural Resources Code § 91.401, for which LBH seeks actual damages and statutory interest. Id. at 14. LBH also seeks a full accounting of production royalties paid under the leases and any deductions or adjustments to those royalties pursuant to sections 91.141 and 91.501-505 of the Texas Natural Resources Code. Id. LBH also seeks a declaratory judgment about Encana's royalty payments under Texas common law, as well as attorney's fees. Id.

         Encana responded by engaging in jurisdictional discovery and removing the case to this Court on the basis of diversity. Id. at 3-4. Encana now requests that LBH's claims be dismissed for failure to state a claim, arguing that all of LBH's claims are premised on an incorrect interpretation of the lease's language and Texas common law. ECF No. 8, at 1, 10. The leases state the royalty is valued "at the wellhead" and "at the well," and Encana argues that, under Texas common law, this language authorizes deducting post-production costs from the downstream sales price and makes any language to the contrary surplusage. Id. at 6-11. Therefore, Encana argues that any pleadings LBH could submit would not remedy the issue, as the law clearly favors Encana. Id. at 13. The parties do not dispute that these leases govern this claim, or that this Court has proper diversity jurisdiction over the dispute.

         II. Legal Standards

         a. 12(b)(6) Standard

         When reviewing a Rule 12(b)(6) motion to dismiss, the court will accept all well-pleaded facts of the complaint as true and construe them in the light most favorable to the plaintiff. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). Per Rule 12(b)(6), a complaint must "state a claim to relief that is plausible on its face." Ashcrofi v. Iqbal, 556 U.S. 662, 677-78 (2009) (quoting Twombly, 550 U.S. at 555). Dismissal is only appropriate if it appears "beyond doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief. Kaiser Alum. & Chem. Sales, Inc. v. Avondale Shipyards, Inc., 611 F.2d 1045, 1050 (5th Cir. 1982).

         b. Texas oil and gas lease construction

         In this diversity case, Texas law governs the interpretation of LBH's leases, and so the question of whether the lease is ambiguous is a question of law for the Court. Warren v. Chesapeake Exploration, L.L.C, 759 F.3d 413, 415 (5th Cir. 2014). "In construing an unambiguous lease, our task is to ascertain the parties' intentions as expressed in the lease." Id. "We presume that the parties intended every clause to have some effect, and we give terms their plain and ordinary meaning unless the instrument reflects that the parties intended a different meaning." Id. "Texas law requires us to enforce an unambiguous lease as written." Id.

         Under Texas common law, a royalty is understood to be free of production expenses, but typically bears "post-production costs, including taxes ... and transportation costs." Chesapeake Exploration, L.L.C. v. Hyder, 483 S.W.3d 870, 872 (Tex. 2016). But parties may contract around this general rule such that a royalty does not bear post-production costs. Id. How such a "no-deductions clause" squares with a royalty that is valued at the well has been thoroughly addressed by both the Texas Supreme Court and the Fifth Circuit. The Texas Supreme Court held in Heritage, and later reaffirmed in Hyder, that parties may contract around having post-production costs deducted from a 'market value at the well' lease, and such clauses have been interpreted in light of these rulings by the Fifth Circuit in Warren and Potts. No-deductions clauses that do not alter the point of valuation do not accomplish this goal.

         In the 1996 Heritage opinion, the Texas Supreme Court held that a certain no-deductions clause was "ineffective to free the ['market value at the well'] royalties from postproduction costs." Hyder, 483 S.W.3d at 876, discussing the holding of Heritage Res., Inc. v. NationsBank,939 S.W.2d 118, 130 (Tex. 1996). The court recognized that a wide variety of royalty clauses exist: "Some are based on 'proceeds,' some on 'amount realized,' while others are based on 'market value.' Some specify the point at which the value of the royalty is determined, such as 'at the well.' Some do not." Heritage, 939 S.W.2d at 125. The specific royalty clause at issue in Heritage the lessee to pay the lessor based on the "market value at the well" of the gas, "provided, however, that there shall be no deductions from the value of Lessor's royalty" for marketing the gas. Id. The Court held that when the royalty is based on the value of the gas at the well, "the concept of deductions of marketing costs from the value of the gas is meaningless." Id. -At the well, the value of gas is "its value in the marketplace at any given point of sale, less the reasonable cost to get the gas to that point of sale, including compression, transportation, and processing costs." Id. Because the value of the gas at the wellhead is calculated by deducting marketing costs from the actual sales price or comparable sales prices, ...

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