[co-author: Madison Schrutka]
A division order is a statement executed by all owners of interests in an oil and gas well. The division order’s essential purpose is to “authorize and direct to whom and in what proportion to distribute” proceeds from the sale of produced oil and gas.[1] In Texas, the payor is entitled to a signed division order from the payee as a prerequisite for payment, but it is the payor’s responsibility to submit the order to the payee for its signature.[2] Upon the division order’s execution, “the payor is [generally] protected from liability even if there is a mistake as to who receives what percentage of production.”[3]
Creating a contractual relationship, the signed division order is binding from the moment, and to the extent it has been acted on.[4] However, it “does not amend any lease or operating agreement between the interest owner and the lessee or operator or any other contracts for the purchase of oil or gas.”[5] Moreover, any provision within the division order that is “in contradiction with any provision of an oil and gas lease is invalid to the extent of the contradiction.”[6]
Erroneous Division Orders: Handling the Danger of Double Liability
In the landmark case of Gavenda v. Strata Energy, Inc., the Supreme Court of Texas (SCOT) addressed whether division orders are “binding until revoked when an operator . . . prepares erroneous division orders [and] underpays royalty owners.”[7] Texas’ standard rule is that until revoked, division orders bind underpaid royalty owners – subject to the principles of unjust enrichment and detrimental reliance. Generally, detrimental reliance protects payors, while unjust enrichment protects underpaid payees.
This binding rule serves as a safeguard for payors who would otherwise be unfairly subjected to double liability.[8] Typically, that danger arises when payors, relying on division orders, “pay out the correct total of proceeds owed, but err in the distribution, overpaying some royalty owners and underpaying others.”[9] If the resulting lawsuits were not estopped, payors “would pay the amount of the overpayment twice—once to the overpaid royalty owner under the division order and again to the underpaid royalty owner through his suit.”[10] In this scenario, the division order remains binding and the underpaid signatory royalty owner’s only relief lies in a suit to recover from the overpaid royalty owner. The basis of that recovery is unjust enrichment: the overpaid royalty owner has erroneously claimed, and is not entitled to, the sum of overpaid royalties that rightfully belongs to the underpaid payee.[11] Therefore, under these circumstances, the statute’s purpose is to protect the payor who detrimentally relied on the signed division order, but also the underpaid payee from an unjustly enriched, overpaid payee.
Nonetheless, payors are the parties most routinely protected by the rule that division orders are binding until revoked. This trend was validated five years before Gavenda, when the SCOT held that an erroneous division order was binding in favor of the payors, even though there was no detrimental reliance on the payors’ part, so long as “they had not profited from their error in preparing the division order.”[12] Per the SCOT, the Gavenda holding provides “stability in the oil and gas industry.”[13] To put it plainly, as long as payors do not benefit from their own mistake, it is a losing battle for payees if they sue to recover from them.
Accordingly, when a payor prepares an “erroneous division order and retains the benefits, Texas courts have held that the division orders were not binding.”[14] Therefore, the payor is liable for the entirety of the payee’s royalties it erroneously retained, but not liable for any royalties it erroneously paid out to other payees.[15]
Strongly Construing the Texas Code in Favor of Payors
While division orders establish the mechanism of settlements and payments, they can be terminated upon thirty days of written notice and no longer bind their signatories.[16] Until then, Section 91.402 of the Texas Natural Resources Code explicitly requires a payor to distribute production proceeds to each payee within certain deadlines after the oil and gas is sold.[17]
Nevertheless, there seems to be a discrepancy between the statute’s explicit language and the meaning the courts have given it. In a nutshell, the Code states that on or before 120 calendar days following the end of the month of the first sale of production, payment is due to each payee, and all subsequent payments must be made promptly based upon the frequency specified in the written agreement; however, if there is no specified frequency, subsequent payments “must be paid no later than 60 days after the end of the calendar month in which subsequent oil production is sold or 90 days after the end of the calendar month in which subsequent gas production is sold.”[18]
In a 2018 case, the SCOT “allowed payees to maintain a cause of action for breach of contract where their lease specified a time limit for payment of royalties,” after holding that Section 91.402 did not distinctly preclude common law claims.[19] Nonetheless, to rule that payees cannot bring a common law breach of contract action for overdue royalty payments, the SCOT held that it first needed “clear language from the Legislature indicating an intent to abrogate a common law cause of action,” as Section 91.402 clearly left out that language.[20]
In 2021, the Legislature responded and unanimously passed Senate Bill 1259, which provided the explicit legislative intent the SCOT found previously deficient.[21] Given the 2018 case where the SCOT recognized that Section 91.402 was “designed to protect the interest of royalty owners,” it is no surprise that the industry supported SB 1259, while royalty owners opposed it.[22] On May 24, 2021, the Bill became effective, enforcing from that day forward that “a payee does not have a common law cause of action against a payor for withholding payments under the Natural Resources Code unless the contract requiring payments specifies that payments to the payee may not be withheld beyond the time limits set out in the Natural Resources Code.”[23] Even if a payee does have a cause of action under this new legislation, it is required to first give the payor written notice of nonpayment by mail before pursuing judicial action.[24] Upon receipt, the payor then has thirty days to either pay the overdue proceeds or respond with the reasonable cause for such nonpayment.[25]
Broadening the Safe Harbor Provision
Section 91.402 also includes the “safe harbor” provision, which permits payors to withhold payment “if there is . . . a dispute concerning title that would affect distribution of payments,” but payors must establish two facts: “(1) that a ‘dispute concerning title’ existed during the time it withheld production payments and (2) that dispute ‘would affect distribution of payments.’”[26] On May 19, 2023, the Freeport-McMoRan Oil & Gas LLC v. 1776 Energy Partners, LLC opinion came down in which the SCOT adopted a very broad interpretation of what a “title dispute” includes within the Texas Suspense Statute. The court reversed a 2021 court of appeals (COA) decision finding that a constructive trust in a related suit does not fall within that category.
In the opinion, the SCOT rejected the COA’s pro-payee argument that the phrase “would affect” requires a “current effect” on payment distribution, and instead, held that “would affect” simply requires “an expected future effect.”[27] Accordingly, the COA incorrectly held that the payor owed the payee interest on the suspended payments solely because the dispute does not “currently” affect payment distribution.[28] Thus, the SCOT clarified that (2)’s only necessary condition required to permit the payor “to withhold the payments without interest” is that “the dispute concerning the title was, at that time, at least expected or likely to influence or alter the distribution of the payments” owed to the payee.[29] This broadens the safe harbor provision’s power in the sense that meeting the invalid “current affect” requirement has a higher threshold in comparison to the lower threshold the valid “would affect” requirement has.
Another portion of the safe harbor provision permits a payor to withhold payments if there is a “reasonable doubt” that the payee had “clear title to the interest in the proceeds of production.”[30] The SCOT additionally rejected this COA’s holding that “issues of reasonableness must be resolved by a factfinder as a question of fact rather than by a court as a matter of law.”[31] While the COA reasoned their holding by stating that “the determination as to whether something is reasonable is often an issue of fact that should be adjudicated by the factfinder because it requires comparison to surrounding circumstances,” the SCOT pointed out that “[r]easonableness has always entailed an objective inquiry.”[32] The SCOT went on to enforce its precedent that:
While questions of reasonableness must be submitted to a factfinder when a genuine disagreement about the facts prevents the law from generating an objective answer, . . . no case citing that proposition can be understood to say that a factfinder must resolve all issues touching on reasonableness. Rather, the legal standard for reasonableness remains objective even if the “controlling facts” are in doubt. Thus, reasonableness may present a question of law “when from the facts in evidence but one rational inference can be drawn.”[33]
Applying that holding to the case at hand, the SCOT found the payee’s contention that the constructive trust placed on its own interests “established its title to the production proceeds” to be the opposite of what is true.[34] It reasoned that upon “imposing a constructive trust, a court concludes the party should not be holding the property at all, which makes the party’s title anything but clear.”[35]
When rightfully withheld, payees do not have a viable cause of action for breach of contract against payors unless, “for a dispute concerning the title, the contract requiring payments specifies otherwise.”[36] Alternatively, when erroneously withheld for any reason after thirty days of receipt of the payee’s notice, the payor is liable to the underpaid payee for the amount of payment the division order entitles it to plus interest.[37] In the first instance, the statute’s function is to protect the payor from the dangers of a clouded title. Meanwhile, in the second instance, the statute’s function is to protect the underpaid payee from a, more or less, opportunistic payor.
A Shift Away from the Pro-Payor Trend?
While Freeport-McMoRan reinforces the Texas Division Order and Suspense Statute’s strength, the Perdido Properties LLC on Behalf of Bremer v. Devon Energy Prod. Co., L.P. opinion, which came down just the day before, appears to undermine it. Although the case also upheld the precedent established in Gavenda, it steps away from Texas’ tradition of being pro-payor. Due to the lack of Texas precedent concerning non-signatories of a division order suing payors that paid royalties to incorrect royalty owners, the COA heavily relied upon North Dakota precedent.[38] Meanwhile, North Dakota has a substantially weaker division order arrangement than Texas.
In the situation involving a royalty owner who has not executed a division order with the payor, the North Dakota Supreme Court (NDSC) held that the payor’s reliance on the title opinion does not absolve it of double liability and the royalty owner can recover underpayment or total nonpayment from the payor.[39] In other words, North Dakota division orders are designed to provide the payor double liability protection from only those who are signatories of the document itself, while non-signatories face no legal barriers provided by such protection. Nonetheless, the NDSC holds that to be entitled to such protection from an underpaid signatory’s suit, the payor must have “detrimentally relied” on the division order by making underpayments according to the signed and executed, yet erroneous document.[40] Meanwhile, in suits brought by non-signatories, it is of absolutely no consequence that a payor detrimentally relied and may be exposed to double liability because it has “not relied to its detriment on any actions taken by the non-signatory” plaintiff.[41] Theoretically, the Texas COA possibly adopts North Dakota’s philosophy on the issue with the logic that by utilizing due diligence and the self-help provided to payors by the safe harbor provision, double liability to a non-signatory can be easily avoided. After all, that is the purpose of the Suspense Statute: permitting payors to suspend royalty payments without interest, if there is any suspicion of a clouded title.
Although the payors took a loss in Perdido, the Texas safeguards favoring payors prevented it from being worse than what it ultimately could have been. For the payor’s protection, the statute of limitations bars all claims for royalty nonpayment that accrued before four years from the date that suit is filed by or on behalf of the royalty owner.[42] However, an even more pervasive caveat to the statute is crucial to note: “a cause of action accrues, and the statute of limitation begins to run when facts come into existence that authorize a party to seek a judicial remedy.”[43] Therefore, such cause of action accrues upon a wrongful act causing legal injury regardless of whether it goes undiscovered until thereafter or whether the resulting damages have not yet occurred.[44]
Nevertheless, a plaintiff-payee can dodge a defendant-payor’s limitations defense by invoking equitable estoppel, which requires the following elements to be proven: (1) the payor “made a false representation or concealed material facts; (2) with actual or constructive knowledge of those facts; (3) with the intent that” the payee would act on the payor’s misrepresentation; (4) to the payee, “who had no means of knowledge of the facts;” and (5) the payee “detrimentally relied” on the misrepresentations.[45] As it functions in all contract claims, equitable estoppel offers protection from the unconscionable acts of an exploitative party.
Moreover, while a debt may be otherwise barred by the statute of limitations, the statute’s effect can be precluded “if the party to be charged acknowledges the debt in writing” thus creating a new obligation.[46] To be successful, it must be proven that the acknowledgment: (1) is “in writing and signed by the party to be charged;” (2) contains an unambiguous “acknowledgement of the justness or the existence of the particular obligation;” and (3) refers to the specific obligation and expresses a willingness to honor it.[47] To differentiate between elements (2) and (3), when the debt is unambiguously acknowledged, “the promise to pay is implied,” but to sufficiently refer to the specific obligation, the amount of the obligation must be capable of “ready ascertainment.”[48] Although it is agreed that modern communication largely occurs via email, there is a split in Texas authority surrounding whether a signature, as required in element (1), is satisfied by an email signature block.[49] However, Perdido might have set the record straight by concluding that “either a typed name of a signature block at the end of an email is sufficient to constitute” such.[50]
While Perdido appears to shift away from the pro-payor trend, the various Texas safeguards that remain in place for the payor’s protection will continue to substantially limit the amount a payee can recover from it. Nonetheless, it is more than likely that the SCOT will take a hard look at this case and possibly even reverse the COA’s decision, as they have done time and time again, to maintain the pro-payor status quo.
Conclusion
The standard rule is that Texas division orders “bind underpaid royalty owners until revoked” with detrimental reliance protecting payors and unjust enrichment protecting underpaid payees. Nonetheless, detrimental reliance is merely a sufficient condition for the payor’s protection, while unjust enrichment is the necessary condition for the payee’s protection. To provide “stability in the oil and gas industry,” the SCOT and the Texas Legislature tend to be pro-payor by minimizing the duties the Texas Division Order and Suspense Statute assigns to payors and maximizing the hoops payees must jump through for a successful cause of action.[51] A petition for review was filed on August 8, 2023, and again on September 5, 2023, and it will be interesting to see the response pro-payee Perdido receives.
[1] Gavenda v. Strata Energy, Inc., 705 S.W.2d 690, 691 (Tex. 1986).
[2] Tex. Nat. Res. Code Ann. § 91.402(c)(1) (Vernon); Prize Energy Res., L.P. v. Cliff Hoskins, Inc., 345 S.W.3d 537, 560 (Tex. App.—San Antonio 2011, no pet.), abrogated on other grounds by Nath v. Tex. Children’s Hosp., 576 S.W.3d 707 (Tex. 2019).
[3] Joseph Shade & Ronnie Blackwell, Primer on the Texas Law of Oil & Gas 62 (5th ed. 2013).
[4] § 91.402(g) (Vernon).
[5] Id. at (c)(2).
[6] Id. at (h).
[7] Gavenda, 705 S.W.2d at 690.
[8] Id. at 692.
[9] Id.
[10] Id.
[11] Id.
[12] Id. (discussing Exxon Corp. v. Middleton, 613 S.W.2d 240 (Tex. 1981)).
[13] Id.
[14] Gavenda, 705 S.W.2d 690; Perdido Properties LLC on Behalf of Bremer v. Devon Energy Prod. Co., L.P., 669 S.W.3d 535, 549 (Tex. App. 2023) (emphasis added).
[15] Id.
[16] § 91.402(g) (Vernon).
[17] Id. at (a).
[18] Id. (emphasis added).
[19] John H. H. Bennett, Oil, Gas, and Mineral Bills Enacted by the 87th Texas Legislature, 18 Tex. J. Oil Gas & Energy L 61, 71 (2023).
[20] Bennett, supra note 18; ConocoPhillips Co. v. Koopmann, 547 S.W.3d 858, 879 (Tex. 2018).
[21] Bennett, supra note 18.
[22]Koopmann, 547 S.W.3d at 878; Bennett, supra note 18.
[23] Katy Wehmeyer & Jordan Stevens, Withholding Royalty Payments After ConocoPhillips Co. v. Koopmann, 52 Tex. Tech L. Rev. 439, 481 (2020); Bennett, supra note 18.
[24] Tex. Nat. Res. Code Ann. § 91.404 (Vernon).
[25] Id. at (b).
[26] § 91.402(b)(1)(A).
[27] Freeport-McMoRan Oil & Gas LLC v. 1776 Energy Partners, LLC, 22-0095, 2023 WL 3556695, at *4 (Tex. May 19, 2023) (emphasis added).
[28] Id.
[29] Id. (emphasis added).
[30] Id. at *5 (emphasis added).
[31] Id.
[32] Id. (emphasis added) (internal quotation marks omitted).
[33] Id.
[34] Id. at *6.
[35] Id. (internal quotation marks omitted).
[36] § 91.402(b-1) (Vernon).
[37] Tex. Nat. Res. Code Ann. § 91.403 (Vernon).
[38] Perdido Properties LLC on Behalf of Bremer, 669 S.W.3d 535, 551 (Tex. App. 2023).
[39] Id.
[40] Id.
[41] Id.
[42] Id. at 555.
[43] Id. at 556.
[44] Id.
[45] Id. at 557.
[46] Id. at 558–59.
[47] Id. at 559.
[48] Id.
[49] Id. at 560.
[50] Id. at 561.
[51] Gavenda, 705 S.W.2d at 692.
