Fort Worth’s Hyder family won its million-dollar fight in the Texas Supreme Court against Chesapeake Energy, with the state’s high court narrowly ruling that the Oklahoma City-based energy giant improperly deducted post-production costs from their royalty checks.
In a 5-4 decision, the majority ruled that the agreement the Hyder family signed with the original production company, a lease that was bought by Chesapeake, specifically barred the company from subtracting the money from the checks.
The justices upheld a 2014 San Antonio appeals court ruling that awarded the Hyder family at least $1 million in royalties, interest and attorney fees.
“Generally speaking, an overriding royalty on oil and gas production is free of production costs but must bear its share of post-production costs unless the parties agree otherwise,” Chief Justice Nathan Hecht wrote for the majority. “The only question in this case is whether the parties’ lease expresses a different agreement. We conclude that it does.”
The case was being widely watched by the oil and gas industry and by property owners suing Chesapeake for millions of dollars over how it deducts the post-production costs from its royalty checks.
“It’s been a five-year journey for the Hyders. We are pleased with the outcome,” said David Drez, the family’s attorney. “This is the third court to agree with us.”
Gordon Pennoyer, a spokesman for Chesapeake in Oklahoma City, declined to comment on the court’s decision Friday.
But during its arguments before the Supreme Court, Chesapeake said that charging the Hyders post-production costs was standard procedure and that not overturning the appeals court’s decision would create a “sea change in Texas oil and gas law.”
The powerful Texas Oil and Gas Association had argued that if the decision goes “uncorrected,” it will “generate confusion and inefficiencies for the oil and gas industry.”
It is unclear how broad an impact the Supreme Court’s decision will have on other cases challenging Chesapeake’s practice of charging for post-production costs when the leases stated they would not be subtracted from royalty checks.
Lawyers monitoring the case had said its impact will depend on whether the justices tackle concerns about a previous Texas Supreme Court ruling — in Heritage Resources v. NationsBank — that permits post-production costs to be deducted even when contracts don't appear to allow it.
But Hecht steered clear of Heritage, saying that it did not influence the majority’s conclusion, but he pointed out that even Heritage said that “parties may modify this general rule by agreement.”
Drez argued that this case involved a specifically negotiated, heavily tailored lease, and that the court’s decision states “that each lease and contract will have to stand on its own.”
Still, the case “is an important guidepost for royalty owners because the general perception, whether it be right or wrong, is that they don’t stand a chance against the operator,” Drez said.
The Hyders were defending what they considered to be a straightforward deal for the gas beneath about 1,000 acres in Tarrant and Johnson counties.
In 2004, they entered into a lease with Four Sevens Oil Co. The nine-page, single-spaced document says the family would receive royalties of 25 percent of the gas’ value at the well, free of any costs from production and processing.
Sophisticated investors, the Hyders also negotiated for 5 percent of what Four Sevens got for any gas taken from a neighbor’s property through a well sitting on their land. Known as an overriding royalty interest, the lease was supposed to be cost-free except for taxes.
But Four Sevens sold the lease to Chesapeake in 2006, and the family contends that problems ensued “almost immediately.” Chesapeake, applying the same process it has used throughout the Barnett Shale, sold the gas to affiliates and paid the Hyders a “weighted average sales price” based on what it was paid by an unaffiliated third party, less post-production costs.
In 2010, the Hyders sued Chesapeake for improperly subtracting post-production costs from their royalty checks. In 2012, state District Judge Melody Wilkinson awarded the family nearly $1 million.
In its arguments before the Supreme Court, Chesapeake’s attorney argued against the appeals court ruling only as it applies to the overriding royalty interest payment. While the Hyder lease was specific about costs charged on gas taken from their property, it was less defined regarding gas from somewhere besides the physical location of the wellhead on their property.
Chesapeake’s lawyer said the Hyders had to pay their share of post-production costs. In court documents, it said that those costs hit about $584,000 at one point and that during that time, the Hyders were paid $17 million in total royalties and overriding royalties under the lease.
In a dissenting opinion. Justice Jeff Brown wrote that Chesapeake’s deductions were proper, saying that post-production activities added value to the Hyders’ overriding royalty. “That Chesapeake undertook to market the gas should not saddle Chesapeake with post-production costs or entitle the Hyders to more than the royalty for which they bargained.”
Joining Hecht in the majority were justices Paul Green, Phil Johnson, Jeff Boyd and John Devine. The dissenting justices were Brown, Don Willett, Eva Guzman and Deborah Lehrmann.
This story contains material from the Star-Telegram archives.
Max B. Baker, 817-390-7714