In a potentially important decision for the oil patch, the San Antonio Court of Appeals has affirmed a $41 million judgment against an operator for failing to pay bonuses owed under a Most Favored Nation (MFN) clause. In a 2-1 decision, the court of appeals held that the plain meaning of the MFN clause required the operator to pay the bonus differential retroactively to the effective date of the primary lease, not prospectively from the effective date of the leases that triggered the MFN obligation.

The dispute in EP Energy E&P Company, L.P. v. Storey Minerals, L.T.D., Maltsberger/Storey Ranch, LLC, and Rene R. Barrientos, Ltd. (No. 04-19-00534-CV) arose from three identical oil and gas leases executed by the parties in 2009 (the so-called “A leases”). Each lease required EP to pay $500 in bonuses per net mineral acre but stipulated in an MFN clause that if EP acquired additional leases on the Maltsberger (MSB) property at a higher bonus amount, EP would pay the difference per net acre. EP subsequently acquired to leases that the parties agree triggered the MFN clause. They disagreed, however, on the amount of increased bonus payments the clause required. MSB sued EP for breach of the A leases and expert and attorney’s fees. Both parties filed traditional summary judgment motions. A La Salle County district court denied EP’s motion and granted MSB’s, ordering EP to amend the A leases and pay the difference between the highest of the two bonus payments ($5,200 per acre) on the new leases and the $500 bonus in the original A leases (MSB sought delay rentals as well, but the trial court determined the MFN clause did not trigger additional delay rental payments). The trial court awarded judgment to MSB for $41 million.

On appeal, the court of appeals affirmed the award (it reversed and rendered on the portion of the trial court’s order requiring EP to amend the A leases). The decision turned on the construction of the following language in the MFN clause:

“ . . . lessee expressly stipulates, warrants, and agrees that it will execute an amendment this lease, effective as of the date of the third party lease on the leased premises, to provide that the lessor hereunder shall receive thereafter the same percentage (per net mineral acre) . . . bonus . . . as any subsequent lessor of the leased premises to the extent that such . . . bonus . . . [is] greater than those provided to be paid herein.

The majority opinion, authored by Justice Chapa, rejected EP’s argument that it only had to make “payments beginning on the acquired lease’s effective date if there were bonuses it decided were payable from that date from that date forward on acreage subject to the A leases” (emphasis added). In the event, the effective date of the acquired lease was September 25, 2013, whereas the primary term of the A leases expired on September 30, 2013. EP claimed that it only owed the additional bonus of $4,700 per acre for acreage on which it determined to pay bonuses for those five days. The majority reached this conclusion based on a construction of the terms “effective” and “thereafter” to mean that the MFN clause required EP to amend the A leases on September 25 to reflect the higher bonus amount and afterward to pay the difference on all acreage subject to the A leases, not just the acreage EP decided it would pay on after it had triggered the MFN. In effect, the majority’s ruling means that the MFN clause triggered an amendment to the original A leases that changed the bonus from $500 to $5,200 as of the effective date of those leases. The majority further found that an addendum to the A leases that allowed EP to defer paying bonuses on certain acreage while MSB cleared title did not change the plain language of the MFN clause to allow split bonus payments. It also brushed aside EP’s argument that in the context of the lease as a whole, the terms “effective” and “thereafter” clearly contemplated prospective additional bonus payments.

Justice Valenzuela’s dissenting opinion adopts EP’s construction of the MFN clause. She reads “effective” and “thereafter” as requiring only prospective payment of additional bonuses. To support this reading, she cites other provisions of the lease that use “effective date” to mean September 30, 2009, whereas the MFN clause used a “effective as of the date of the third party lease.” She further interprets “thereafter” to limit the duration of the additional payments to the period beginning “after” the execution of the third party lease. Third, she notes that the MFN clause also applied to royalty and rentals, but MSB conceded that payment of additional royalties were prospective only because they are tied to future production. Moreover, the addendum to the lease authorized the payment of bonuses in stages pending MSB’s actions to clear title, indicating the intent of the parties to modify “bonus” to mean something other than “upfront payment of cash consideration.” In summary, the dissent argues that harmonizing the various provisions of the lease and the addendum produces the result argued by EP.

This decision should certainly be of interest to producers and land and royalty owners all over the Eagleford if their MFN clauses are similar to the one at issue here. The presence of the dissent makes it a good candidate for SCOTX review, should EP decide to take it up. The amount of the judgment certainly suggests that further appeal is warranted.

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