The safe harbor provision in the statute dictating the time in which an operator must distribute oil and gas proceeds to a payee is at issue in a case the Texas Supreme Court will hear on February 1.
1776 Energy Partners, LLC v. Freeport-McMoran Oil & Gas, LLC (No. 04-20-00468-CV; No. 22-0095) arose from a dispute over whether Freeport, the operator of certain oil and gas wells as part of a joint production agreement with 1776, unreasonably withheld proceeds of production during the pendency of a separate lawsuit that challenged 1776’s title to mineral interests produced under the Freeport agreement. In that lawsuit, commenced a few months prior to the execution of the joint production agreement at issue in this case, Longview Energy alleged that 1776 breached its fiduciary duty to Longview by taking a corporate opportunity. The trial court found in favor of Longview and ordered 1776 to transfer legal title to its mineral interests to Longview. Pending such transfer, the court ordered further, 1776 was required to hold legal title as a constructive trustee for Longview’s use and benefit. 1776 appealed the judgment and posted a supersedeas bond to suspend enforcement. Shortly thereafter, Freeport stopped sending payments due under the joint operating agreement to 1776.
1776 subsequently sued Freeport for withholding payments under the JOA and for interest accrued on those payments. Freeport answered that the safe harbor provision, § 91.402(b), Natural Resources Code, authorized it to withhold payments if there is a dispute concerning title that affects the distribution of payments or a reasonable doubt that the payee (1776) has clear title to the interest in the proceeds of production. Freeport argued that the Longview lawsuit met both of the statutory conditions. The trial court agreed and granted summary judgment for Freeport and awarded attorney’s fees. 1776 appealed.
The San Antonio Court of Appeals reversed and remanded to the trial court. On appeal, 1776 argued that the Longview judgment did not affect the distribution of proceeds because 1776 continued to hold title to the interests pending appeal (the judgment ordering it to transfer the interests had been superseded, preserving the status quo ante). Alternatively, 1776 contended, it held title as trustee of the constructive trust created by the Longview judgment. Freeport countered that until 1776 exhausted its appeals of the Longview judgment, the title dispute hung in the air. (In 2017, SCOTX affirmed the San Antonio Court of Appeals’ ruling reversing the Longview judgment and rendering a take-nothing judgment in favor of 1776).
The court of appeals found it unnecessary either to consider the effect of the supersedeas bond or whether the Longview judgment created a dispute concerning title. Instead, the court resolved the issue in Longview’s favor based on the statutory language requiring a title dispute “to affect the distribution of payments.” Here, the court reasoned, the Longview judgment did not affect the distribution of payments at all. Whether 1776 held title outright or in a constructive trust for Longview made no difference to the Freeport’s obligation to pay the proceeds under the joint operating agreement. Regarding Freeport’s argument that the Longview judgment raised a reasonable doubt that 1776 had clear title as a matter of law, the court held that 1776 created a fact issue as to the “reasonableness” of Freeport’s withholding because Freeport was the only operator that withheld payments to 1776 on interests potentially affected by the Longview judgment. Thus, the trial court erred in granting summary judgment to Freeport on that issue.
Freeport’s petition argues that the statute does not require operators to analyze the circumstances when faced with objective evidence of a title dispute, in this case a trial court judgment stating that the mineral interests at issue belonged to somebody else. One of the primary purposes of the safe harbor provision is to prevent the double payment of proceeds, first to the ostensible title owner and second to a successful claimant in a title dispute. Freeport contends that the court of appeals’ decision raises just that possibility. Had the Longview judgment been upheld instead of reversed, it would have placed Freeport in the position of having paid the proceeds to the wrong party, with no assurance that they would ever have made their way into Longview’s bank account. This is the classic scenario the statute aims to avoid. We think it likely that SCOTX accepted review to make sure the statute works the way it’s supposed to.
