Anderson Living Trust v. Energen Res. Corp., 16-2124

• Decision Date: 09 January 2018
• Docket Number: No. 16-2124,16-2124
• Citation: 879 F.3d 1088
• Parties: The ANDERSON LIVING TRUST f/k/a The James H. Anderson Living Trust; The Pritchett Living Trust; J. Richie Fields; The Tatum Living Trust; Neely-Robertson Revocable Family Trust, Plaintiffs-Appellants, v. ENERGEN RESOURCES CORPORATION, Defendant-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

879 F.3d 1088

The ANDERSON LIVING TRUST f/k/a The James H. Anderson Living Trust; The Pritchett Living Trust; J. Richie Fields; The Tatum Living Trust; Neely-Robertson Revocable Family Trust, Plaintiffs-Appellants,

v.ENERGEN RESOURCES CORPORATION, Defendant-Appellee.

No. 16-2124

United States Court of Appeals, Tenth Circuit.

FILED January 9, 2018

Bradley D. Brickell, Brickell & Associates, P.C., Norman, Oklahoma (Margaret M. Branch and Cynthia L. Zedalis, Branch Law Firm, Albuquerque, New Mexico, Karen Aubrey, Law Office of Karen Aubrey, Santa Fe, New Mexico, and Brian K. Branch, Law Office of Brian K. Branch, Albuquerque, New Mexico, with him on the briefs) for Appellants.

Christopher A. Chrisman, Holland & Hart LLP, Denver, Colorado (Bradford C. Berge, Holland & Hart LLP, Santa Fe, New Mexico, Jessica M. Schmidt, Holland & Hart LLP, Denver, Colorado, with him on the brief) for Appellee.

Before TYMKOVICH, Chief Judge, HARTZ and O’BRIEN, Circuit Judges.

O’BRIEN, Circuit Judge.

Fossil fuels are the decomposed remains of pre-historic flora (coal) and fauna (oil and gas). They have driven the world’s economy (particularly that of the United States) for over a century. Discovering marketable deposits, extracting them from the ground, refining them, and delivering them to consumers in useful form is big business, on one hand fraught with risk and on the other richly rewarding. That being so, it has attracted the attention of governments as a lucrative source of tax revenue as well as royalties, bonuses, etc., derived from government-owned reserves and as a way of directing public policy. Since oil and gas are the most energy dense¹ and convenient of the fossil fuels, litigation and regulation abound with respect to them. But, in large measure mineral owners (private and public) and those involved with mineral producers have been free to contractually "strike their own deals." Myriad matters are involved; here we are principally concerned with construing the language of leases in accordance with prevailing law—both statutes and case law. Statutes, of course, properly direct policy. So do cases, more covertly, but no less dramatically.

Oil and gas law is rife with duties owed by the lessee to the lessor. Some of those duties are expressed in an agreement (the lease). Others duties are imposed by the courts as implied covenants. See generally , 6 Peter Linzer, Corbin on Contracts § 26.1 (Joseph M. Perillo ed. 2010). This case involves the implied covenant to market gas. It benefits the lessor, in particular, by insuring that the lessee uses reasonable efforts to market potential production. That way the lessor can enjoy the benefits the lease provides. This case deals with that implied covenant, but more particularly with what has come to be known as the marketable condition rule. In its purest form, that advocated by appellants, it not only requires the lessor to market the gas, but to do so solely at its expense. Colorado has adopted a version of the marketable condition rule, which applies only when the lease does not provide otherwise. Years ago we predicted New Mexico would not adopt the marketable condition rule and so far neither the legislature nor the New Mexico Supreme Court has done so. Accordingly, our decision rests on the terms of the leases involved. We rely on the text of the leases and the meaning commonly ascribed to the language used (the essence of the common law, which reflects the practices of the community, rather than dictates practices to the community).

The San Juan Basin, located in northwestern New Mexico and southern Colorado, is a rich source of oil and natural gas. Energen owns and operates oil and gas wells in the Basin.² Its wells are subject to leases and other agreements (many of which are quite old) requiring it to pay a monthly royalty or overriding royalty³ on production to the Anderson Living Trust, the Pritchett Living Trust, the Neely-Robertson Revocable Family Trust (N-R Trust), and the Tatum Living Trust. The royalty interests of the Anderson, Pritchett, and N-R Trusts (collectively the New Mexico Trusts) derive from wells located in New Mexico, the Tatum Trust’s royalty interest from wells located in Colorado.

Believing Energen was systematically underpaying royalties, all of the Trusts filed a putative class action complaint against it.⁴ The New Mexico Trusts claimed Energen was improperly deducting from their royalties their proportionate share of (1) the costs it incurs to place the gas produced from the wells in a marketable condition (post-production costs) and (2) a privilege tax the State of New Mexico imposes on natural gas processors (the natural gas processors tax). They also alleged Energen had not timely paid royalties or interest thereon, as required by the New Mexico Oil and Gas Proceeds Payments Act. Both the New Mexico Trusts and the Tatum Trust further claimed Energen was wrongfully failing to pay royalty on the gas it used as fuel.

The district judge dismissed the New Mexico Trusts’ marketable condition rule claim for failure to state a claim under Fed. R. Civ. P. 12(b)(6) and entered summary judgment in favor of Energen on the remaining claims. All of the Trusts appeal from those judgments.⁵ Our review is de novo. Birch v. Polaris Indus., Inc. , 812 F.3d 1238, 1251 (10th Cir. 2015) (grant of summary judgment is reviewed de novo); Thomas v. Kaven , 765 F.3d 1183, 1190 (10th Cir. 2014) (grant of motion to dismiss under Fed. R. Civ. P. 12(b)(6) is reviewed de novo).

For the most part we agree with the district judge, particularly in the following respects:

First , under New Mexico law, Energen had the duty to diligently market the gas for the benefit of the New Mexico Trusts but that duty did not prohibit it from deducting from their royalty payments their proportionate share of post-production costs—those costs necessary to make the gas marketable (i.e., the marketable condition rule does not apply in New Mexico).

Second , nothing in the New Mexico Natural Gas Processors Tax Act or other New Mexico law prohibited Energen from deducting the Trusts’ proportionate share of the tax from their royalties.

Finally , the Anderson and Pritchett Trusts’ lease allows Energen to use produced gas as fuel without paying royalty on it.

In some respects, we part ways with him. They relate to: (1) the fuel gas claims made by the N-R Trust and Tatum Trust and (2) the New Mexico Trusts’ claim under the New Mexico Oil and Gas Proceeds Payments Act. As to the former, the N-R Trust’s overriding royalty agreement requires royalty to be paid on all gas produced, including that gas used as fuel. And the Tatum Trust’s leases explicitly prohibit Energen from deducting post-production costs (Energen treats its use of the fuel gas as an in-kind post-production cost). Moreover, the "free use" clauses and royalty provisions in the Tatum Trust’s leases limit the free use of gas to that occurring on the leased premises. Because use of the fuel gas occurs off the leased premises, Energen owes royalty on that gas. With regard to the latter, the judge was right in permitting Energen to hold funds owed to the N-R Trust in a suspense account until a title issue concerning a well was resolved in favor of that Trust. However, he did not address whether the N-R Trust was entitled to statutory interest on those funds. It was so entitled, yet the current record (at least as we read it) does not show interest to have been paid on the funds.

We now explain. Because all claims do not apply to all appellants, we discuss the issues separately, providing a brief background of the facts relevant to each.⁶

I. Marketable Condition Rule—New Mexico Trusts

A. Background

There is no market at the wellhead on the leased properties for the gas produced from Energen’s wells. See 8 Howard R. Williams & Charles J. Meyers, Oil and Gas Law , at 830 (2011) (defining "[p]roduction of gas" as "[t]he act of bringing forth gas from the earth"). The gas must first be gathered, compressed, dehydrated, and treated.⁷ Energen contracts with third-party companies to perform these services. It then sells the processed gas at the tailgate of the third-party processing plants to various energy companies.

Energen pays the New Mexico Trusts, as royalty, a portion of the downstream sales price. However, it deducts from that price each Trust’s proportionate share of the fees it pays to third-party companies to make the gas marketable (post-production costs).

The New Mexico Trusts claim this deduction is improper because, in their words, New Mexico law imposes an implied duty on Energen to market the gas for the benefit of the royalty owners and that duty necessarily prohibits Energen from deducting post-production costs from their royalty payments (generally referred to as the marketable condition rule).⁸

The New Mexico Trusts’ leases set the basis for royalty payments as the "market value at the well" or the "prevailing field market price." (Appellants’ App’x at 342 (N-R Trust), 338 (Anderson and Pritchett Trusts).) Determining those amounts, however, is not straightforward, because there is no market "at the well" for gas produced in the San Juan Basin. As we explained in Abraham v. BP America Production Co. :

In order to determine the market value of the unprocessed gas at the well, producers sell refined natural gas and NGLs [natural gas liquids] at the tailgate of the processing plant (i.e., after processing) to establish a base sales amount, and deduct from that amount costs for transportation, processing, etc. This is called a "netback" or "workback" method, and it is widely accepted as the best means for estimating the market value of gas at the well where no such market exists.

685 F.3d 1196, 1200 (10th Cir. 2012).

Properly understood, the netback method is not a means of cost-shifting; it is a means of determining the net profit on the oil and gas by "netting" the gross profit.

The post-production expenses are not subtracted from the sales...