Supreme Court of Texas Update: Chesapeake Exploration, L.L.C. v. Hyder

Supreme Court of Texas

Supreme Court of Texas

Chesapeake Exploration, L.L.C. v. Hyder

No. 14-0302

Case summary written by Nirav Patel, Executive Managing Editor.

CHIEF JUSTICE HECHT delivered the opinion of the Court, in which JUSTICE GREEN, JUSTICE JOHNSON, JUSTICE BOYD, and JUSTICE DEVINE joined.

Chesapeake Exploration, L.L.C. (Chesapeake) acquired a mineral lease in the Barnett Shale, consisting of nearly 950 acres. The lease contained a lessor’s royalty for 25% “of the price actually received by the Lessee” for all gas production. The royalty was to be “free and clear of all production and post-production costs and expenses.” The lease also contained a “perpetual, cost-free (except only its portion of production taxes) overriding royalty” of 5% of gross production obtained from any directional wells.

The lessors, the Hyder family, filed suit after discovering post-production expense deductions from their lessor’s royalty and overriding royalty. The trial court rendered judgment for the Hyders, determining that the post-production costs were wrongfully deducted from the royalties. The court of appeals affirmed. On appeal to the Supreme Court of Texas, Chesapeake only challenged the lower court’s judgment regarding the overriding royalty.

The Court first noted that an overriding royalty is generally free of production costs, but subject to post-production costs, such as transportation costs and taxes. This general rule, however, can be modified by agreement of the parties.   Chesapeake argued that the cost-free language in the overriding royalty clause did not make it free of post-production expenses. Rather, Chesapeake stated that this language was merely repeating the general rule that an overriding royalty is free of production costs. The Hyders argued that the “cost-free” language must be given effect and that the only way to do so would be to interpret it as free of post-production costs, in addition to being free of production costs.

The Hyders also drew the Court’s attention to the parenthetical exception for production taxes in the cost-free language of the overriding royalty. The Court noted that “[i]t would make no sense to state the royalty is free of production costs, except for postproduction taxes.” According to the Court, this would be similar to saying “no dogs allowed, except for cats.” Ultimately, the Court affirmed the court of appeals’ decision—the overriding royalty was free of both production and post-production costs.

The Court did not give any effect to a so-called Heritage disclaimer in the lease, which stated that the Court’s 1996 decision in Heritage Resources v. NationsBank N.A. should have no effect on the lease. The Heritage decision did not directly apply to this case because the Heritage royalty was based on market value at the well, while the overriding royalty in this case was based on gross production.

JUSTICE BROWN, joined by JUSTICE WILLET, JUSTICE GUZMAN, and JUSTICE LEHRMANN, dissenting.

The dissenting Justices did not agree that the cost-free language of the overriding royalty could only refer to post-production costs. They noted that parties commonly decide to state that the royalty interest is free of production costs, even though this is the general rule. Thus, the dissenting Justices did not think the cost-free language expressed “an intent to abrogate the default rule that the lessee bears post-production costs.” Finally, the Court noted that production taxes are not always post-production costs and that parties “often allocate tax liability on the royalty owners while at the same time specifically emphasizing that the royalty is free from production costs.” Thus, the dissenting Justices did not think the reference to production taxes supported the Hyders’ argument that “cost-free” means free of post-production costs.

Back to top