Wagner & Brown, Ltd. v. Sheppard

• Decision Date: 21 November 2008
• Docket Number: No. 06-0845.,06-0845.
• Citation: 282 S.W.3d 419
• Parties: WAGNER & BROWN, LTD. et al, Petitioners, v. Jane Turner SHEPPARD, Individually and as Independent Executrix of the Estate of Sybil Turner, Deceased, Respondent.
• Court: Texas Supreme Court

282 S.W.3d 419

WAGNER & BROWN, LTD. et al, Petitioners, v. Jane Turner SHEPPARD, Individually and as Independent Executrix of the Estate of Sybil Turner, Deceased, Respondent.

No. 06-0845.

Supreme Court of Texas.

Argued December 5, 2007.

Decided November 21, 2008.

Rehearing Denied June 5, 2009.

J. Gregory Copeland, Macey Reasoner Stokes, Baker & Botts, Houston, TX, Jerry S. Harris, Harbour Smith Harris & Merritt, Longview, TX, Julie Ann Walker, Miller Mentzer, P.C., Palmer, TX, for Petitioners.

Ronald O. Holman, Alan Edward Wright, Ben L. Mesches, Haynes & Boone, L.L.P., Dallas, TX, for Respondent.

Michael E. McElroy, McElroy Sullivan & Miller, L.L.P., Pamela Stanton Baron, Austin, TX, for Amicus Curiae.

Justice BRISTER delivered the opinion of the Court.

One observer has estimated that 85 percent of the 27,000 wells drilled in the East Texas oil field in the first half of the 20th century were unnecessary—resulting in a huge waste of money and natural resources.¹ As one means of reducing excessive drilling, the Texas Legislature provided for voluntary pooling in 1949,² and compulsory pooling in 1965.³

Since then, this Court has never addressed how a pool of producing properties is affected if a lease in the pool expires. In this case, the courts below held that expiration of a lease removes those minerals from the pool and bars recovery of any costs incurred before termination. But the pooling agreement here did not depend on the continuation of underlying leases, nor was the equitable right of reimbursement for improvements necessarily extinguished by termination of the lease. Accordingly, we reverse and remand for further proceedings.

I. Background

Jane Sheppard, a CPA and retired family lawyer, owns 1/8th of the minerals underlying a 62.72-acre tract in Upshur County, Texas.⁴ C.W. Resources, Inc. leased her 1/8th interest, and along with Wagner & Brown, Ltd. leased the other 7/8ths of the minerals from other owners. Sheppard's lease had a special addendum providing that if royalties were not paid within 120 days after first gas sales, her lease would terminate the following month.⁵

Sheppard's lease also authorized pooling with adjacent tracts. On September 1, 1996, C.W. Resources, Wagner & Brown, and mineral lessees on adjacent tracts signed a unit agreement pooling the Sheppard tract and eight others to form the W.M. Landers Gas Unit.⁶ One month later, a gas well was successfully completed and began producing, and a second well was completed in September 1997. Both wells were physically located on the Sheppard tract, but pursuant to the unit agreement proceeds and costs were split among all the tracts in proportion to acreage.

The original unit agreement designated C.W. Resources as operator of the unit. In September 2000, Wagner & Brown took over that position, and discovered that Sheppard had not been paid royalties within 120 days of the first gas sales. Wagner & Brown offered Sheppard a new lease, but with two producing wells already on her property, she declined. The parties agree that Sheppard's lease terminated on March 1, 1997, and since then she has been an unleased co-tenant, entitled to her share of proceeds from minerals sold less her share of the costs of production and marketing.

The dispute here concerns both the proceeds and the costs. Regarding the proceeds, the question is whether the termination of Sheppard's lease also terminated her participation in the unit (in which case she is entitled to 1/8th of 100 percent of production, as both wells are on her tract), or did not do so (in which case she is entitled to 1/8th of only 51.3 percent of production—the proportion her tract bears to total acreage in the unit).⁷ Regarding the costs, the question is whether Sheppard should bear any costs incurred before her lease terminated, or any costs incurred after the lease terminated that relate to the unit but not her lease.

The trial court granted summary judgment for Sheppard, finding that termination of the lease also terminated her participation in the unit, that she was not liable for any costs incurred before termination, and that she was liable for costs incurred after termination only if they pertained solely to her lease; the court of appeals affirmed.⁸ For the reasons stated below, we disagree.

II. Does Termination of the Lease Also Terminate the Unit?

Sheppard's 1994 lease contained a standard industry pooling clause that provided:

Lessee shall have the right but not the obligation to pool all or any part of the leased premises or interest therein with any other lands or interests.... Production, drilling or reworking operations anywhere on a unit which includes all or any part of the leased premises shall be treated as if it were production, drilling or reworking operations on the leased premises, except that the production on which Lessor's royalty is calculated shall be that proportion of the total unit production which the net acreage covered by this lease and included in the unit bears to the total gross acreage in the unit.... In the absence of production in paying quantities from a unit, or upon permanent cessation thereof, Lessee may terminate the unit by filing of record a written declaration describing the unit and stating the date of termination. Pooling hereunder shall not constitute a cross-conveyance of interests.

The Designation of Unit signed by the lessees of the various "leases and lands" included in the pool provided that they "hereby pool and combine said leases and the lands ... into a single pooled unit or unitized area for the development of and production of gas and associated hydrocarbons. ..."

We disagree with Wagner & Brown that the portion of Sheppard's pooling clause regarding termination for lack of production resolves this case. That clause provides that the unit "may terminate" if production ceases, but there is nothing to show this was intended to be the exclusive means. The documents do not specify what happens to the unit when one lease terminates, so this case calls for interpretation rather than plain reading.

But we agree that a proper interpretation of these documents indicates the termination of Sheppard's lease did not terminate her participation in the unit. A lease is not necessarily required for pooling; mineral owners can join a pool even if no lease exists.⁹ Here, both Sheppard's lease and the unit agreement pooled certain "premises" and "lands," not just their leased interests. Although Sheppard's lease expired, the lands themselves obviously did not. Thus, while termination of Sheppard's lease changed who owned the mineral interests in the unit, it did not cause the unit to terminate because it was a pooling of lands, not just leases.

On precisely this basis, the Second Court of Appeals held in Ladd Petroleum Corp. v. Eagle Oil & Gas Co. that termination of a lease does not terminate a unit.¹⁰ The lease in Ladd allowed pooling with "other lands" as well as other leases, so the unit survived the termination of one lease because "the continuing validity of any such pooling was not dependent upon a subsisting leasehold estate in the adjacent land."¹¹ In this case as in Ladd, lands as well as leases were pooled, so the tracts dedicated to the unit survived even if the related leases did not.

The court of appeals here distinguished Ladd on the ground that it involved termination of an entire pool, while Sheppard seeks only termination of her participation in it.¹² But there cannot be one rule of contract interpretation for small mineral interests and a different rule for large ones. If Sheppard's original mineral interest had been 8/8ths rather than 1/8th, the ruling she seeks would have cut off all production for the other members in the pool just as occurred in Ladd. And if her original interest had been 5/8ths or more, her share would have curtailed their share, even though they had nothing to do with letting her lease terminate.¹³

The court of appeals relied on Texaco, Inc. v. Lettermann, in which the Seventh Court of Appeals held that the termination of two out of the three leases in a unit resulted in termination of the pool.¹⁴ But the lease in Lettermann only authorized pooling "with the gas leasehold estate" of adjacent lands.¹⁵ Thus, when those leasehold estates terminated, so did the pool. But that does not mean a unit formed by pooling lands must terminate on the same basis as one formed by pooling only leases.

The court of appeals also reasoned from the premise that the pooling agreement transferred only the operator's interest, leaving Sheppard's possibility of reverter unimpinged. But her lease allowed pooling of "all or any part of the leased premises or interest therein," and Sheppard's reverter was certainly an interest in the leased premises. "When a unit is properly pooled, the owners of the minerals or reversionary interests in a separate tract within the unit surrender their right to receive their interest in all production from wells located on their own tract...."¹⁶ Just as pooling impinges on a mineral owner's royalty interest,¹⁷ it also may impinge on an owner's possibility of reverter.

The parties invite us to decide the question here based on general principles rather than the terms of the particular documents involved. Wagner & Brown urges that termination of a lease should never terminate a pool, pointing out that pooling benefits mineral owners, operators, the state, and the environment by reducing the number of wells needed to maintain efficient production while protecting correlative rights.¹⁸ Sheppard urges adoption of a treatise's view that "pooling can extend no longer than the lease itself" because a lessor grants only "a power to pool the leasehold rights."¹⁹

But oil and gas leases in general, and pooling clauses in particular, are a matter of contract.²⁰ Just as owners and operators generally must agree to create a pool,²¹ they should also be able to agree when one...