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Ulibarri v. Southland Royalty Co., LLC

United States District Court, D. New Mexico

August 23, 2019

GERALD ULIBARRI and WHITE RIVER ROYALTIES, LLC, Plaintiffs,
v.
SOUTHLAND ROYALTY COMPANY, LLC, Defendant.

          MEMORANDUM OPINION AND ORDER

          ROBERT C. BRACK SENIOR U.S. DISTRICT JUDGE.

         The parties' cross-motions for summary judgment in this oil and gas royalty dispute center on a question of contract interpretation-does the phrase “the proceeds of the gas, as such” in a lease provision require royalty payments to be calculated on the value of natural gas when it first emerges from the wellhead? If so, Plaintiffs likely cannot sustain their claims that Defendant has been improperly calculating their payments. If such language is not synonymous with calculations “at the well, ” Plaintiffs' claims may proceed. There are numerous other legal issues at play in this case, but at this stage the Court need only determine whether the relevant lease language clearly contemplates royalty payments “at the well” or clearly contemplates payments at some other downstream valuation point where proceeds are actually generated. Having considered the submissions of counsel and relevant law, the Court finds that the language clearly contemplates neither. Thus, New Mexico law dictates that the ultimate interpretation of this ambiguous contract language should be left up to the finder of fact following the development of the record.

         I. Background

         This case first reached the Court in March 2016, when Defendant Southland Royalty Company, LLC (Southland) removed Plaintiff Gerald Ulibarri's original class action complaint. (Doc. 1 (Compl.) at 1.) The original complaint alleged breach of contract, breach of implied duty to market, and violations of the New Mexico Oil and Gas Proceeds Payment Act (OGPPA). (Doc. 1-1 ¶¶ 32-53.) The claims were based on allegations that Southland had been underpaying royalties to leaseholders by improperly deducting from their royalty payments proportionate shares of: (1) the New Mexico Natural Gas Processor's Tax, and (2) the post-production costs of processing and otherwise making natural gas marketable for sale. (Id. ¶¶ 16-31.) The matter was stayed pending the resolution of Anderson Living Trust v. Energen Resources Corp., a Tenth Circuit case addressing nearly identical issues and many of the same lease agreements. See 879 F.3d 1088 (10th Cir. 2018), amended and superseded on reh'g, 886 F.3d 826 (10th Cir. 2018). (See also Doc. 30.) In early 2018, the Tenth Circuit resolved Energen, holding that production companies can pass along to leaseholders a proportionate share of the Natural Gas Processors Tax. 886 F.3d at 831. In addition, the court held that the “marketable condition rule” does not apply in New Mexico- meaning lessees can “deduct[] from [lessors'] royalty payments their proportionate share of post-production costs-those costs necessary to make the gas marketable.” Id.

         Following the Energen decision, Mr. Ulibarri twice amended his complaint. (See Docs. 41; 99.) The First Amended Complaint made two significant changes to the definition of the proposed class and his claims against Southland. (Doc. 41.) First, Mr. Ulibarri excluded from the putative class definition any individuals or entities whose lease agreements provide for royalty payments based on “market value at the well, ” “the prevailing field market price, ” or any other agreement language stating that value should be calculated “at the well.” (Id. ¶ 1.) This change was based on his position that the Tenth Circuit's holding in Energen narrowly applies to only certain types of leases, and thus allows the deduction of post-production costs only insofar as that deduction is necessary to calculate the value of the gas “at the well.” (See Doc. 37 at 2-3.)

         As the Tenth Circuit explained in Energen, natural gas is often not marketable when it is first produced (i.e., “at the well”). See 886 F.3d at 832. Thus, when a lease agreement calls for royalties to be calculated based on the value of the gas at the well, producers must determine this value using a “netback” or “workback” method of calculation. See Id. at 832-33. This involves calculating a price for the natural gas “at the well” by selling the natural gas after it has been processed into marketable condition, then deducting the post-production costs that were necessary to prepare it for sale to actually earn that value. See Id. at 832 (explaining that the leases in Energen “set the basis for royalty payments as the ‘market value at the well' or the ‘prevailing field market price.' Determining those amounts, however, is not straightforward, because Energen does not sell the gas it produces on these leased properties ‘at the well'” (citations omitted).) The First Amended Complaint thus asserts that while Energen allows the deduction of post-production costs when the lease requires calculating royalties “at the well, ” it is still improper to deduct post-production costs from royalties paid under all those leases that don't require calculations of value “at the well.” (See Doc. 41 ¶¶ 7-26.) Instead, under those leases, Southland should base payments on the actual sales proceeds of the natural gas and related products derived from its wells. (See id.)

         The Second Amended Class Action Complaint (Doc. 99 (2d Am. Compl.)) again revised the definition of the putative class and added White River Royalties, LLC (White River) as a named plaintiff. (See Id. at 1.) Plaintiffs' proposed class includes any person to whom Southland has paid royalties since January 1, 2015, pursuant to a lease containing one of four different types of royalty payment provisions that Plaintiffs claim do not require calculations at the well.[1] (See id. ¶ 1.) Plaintiffs Ulibarri and White River hold lessor's interests in natural gas leases with Southland that contain identical “Proceeds Royalty Provisions, ” (id. ¶¶ 11, 13-15), which require payment of “a specified percentage of the proceeds of the gas, as such, for gas from wells where gas only is found.” (Id. ¶ 1 (quotation marks omitted).) Thus, only Proceeds Royalty Provisions are relevant to the parties' cross-motions for summary judgment on the lease interpretation issue.

         Southland argues that such language “unambiguously provides that Plaintiffs are entitled to the value of the gas at the well, which is the amount actually received by Southland for the sale of the gas, less a proportionate share of costs incurred after the gas is brought to the surface at the well[.]” (Doc. 124 at 10 (capitalization altered).) To support this interpretation, Southland points to dictionary definitions of the term “proceeds” and the phrase “as such” (see Id. at 10-13), as well as caselaw illustrating that the phrase ‘“the gas, as such' in the Proceeds Royalty Provision means the exact gas that is produced by Southland at the wellhead.” (Id. at 13.) Southland also offers expert witness testimony opining that “[i]n 1953 and 1955, when Plaintiffs' predecessors in interest entered into the Subject Leases, gas produced from the pertinent wells would have been sold at the wellhead.” (Id. at 18.)

         Plaintiffs, on the other hand, argue that “pursuant to the plain language of the Proceeds Royalty Provision, Southland [is] required to pay Plaintiffs royalties based upon proceeds received on the sale of the natural gas products which it sold to third party purchasers” not at the well but “at the tailgate of the applicable processing plant.” (Doc. 168 at 18.) Plaintiffs point out that the relevant language includes no references to “the well, ” “market value, ” or “net proceeds” which would allow for the deduction of processing costs, and instead directs such payments to be calculated solely based on proceeds. (Id. at 18-20.)

         Further, Plaintiffs argue, the proffered testimony of Defendant's expert witness Kris Terry is inadmissible because she opines on the meaning of the phrase “as such” solely to change the terms of an unambiguous contract after the fact and her opinions are not based on a reliable foundation. (Id. at 22-23.) Plaintiffs seek partial summary judgment on their claims for breach of contract and violation of the OGPPA, arguing that the leases' plain language and relevant caselaw dictate that “Southland is required to pay royalties based on the proceeds received on the sale of residue gas and natural gas liquids to third party purchasers.” (Id. at 17.)

         In addition to the issue of whether Proceeds Royalty Provisions require valuation at the well, Southland's motion for summary judgment raises two additional arguments: (1) that “Plaintiffs may not bring claims under the New Mexico Oil and Gas Proceeds Payment Act because it does not apply retrospectively to the subject leases” (Doc. 124 at 22 (capitalization altered)); and (2) that any suggestion in the Second Amended Complaint that the putative class should include overriding royalty interest owners cannot be sustained because overriding royalty interests arise “through a subsequent conveyance instrument by a lessee, acting as assignor[, ]” and are thus not governed by the underlying leases (id. at 24-25).

         II. Legal Standards

         A. Summary Judgment

         Summary judgment is appropriate when the Court, viewing the record in the light most favorable to the nonmoving party, determines “that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a); see also Garrison v. Gambro, Inc., 428 F.3d 933, 935 (10th Cir. 2005). A fact is “material” if it could influence the determination of the suit. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). A dispute over a material fact is “genuine” if a reasonable trier of fact could return a verdict for either party. Id. The moving party bears the initial responsibility of showing “an absence of evidence to support the nonmoving party's case.” Bacchus Indus., Inc. v. Arvin Indus., Inc., 939 F.2d 887, 891 (10th Cir. 1991) (quoting Celotex Corp. v. Catrett, 477 U.S. 317, 325 (1986)). Once the moving party meets this burden, Rule 56 “requires the nonmoving party to go beyond the pleadings and by affidavits, or by the depositions, answers to interrogatories, and admissions on file, designate specific facts showing that there is a genuine issue for trial.” Celotex, 477 U.S. at 324 (citation and quotation marks omitted).

         B. Oil and Gas Lease Interpretation

         “In New Mexico, oil and gas leases are interpreted under the same principles as any other contract.” King v. Estate of Gilbreath, 215 F.Supp.3d 1149, 1164 (D.N.M. 2016) (citing ConocoPhillips Co. v. Lyons, 299 P.3d 844, 852 (N.M. 2013); Continental Potash, Inc. v. Freeport-McMoran, Inc., 858 P.2d 66, 80 (N.M. 1993); Elliott Indus. Ltd. P'ship v. BP Am. Prod. Co., 407 F.3d 1091, 1112 (10th Cir. 2005)). “The primary objective in construing a contract is to ascertain the intention of the parties[, ]” Continental Potash, Inc., 858 P.2d at 80 (quoting Mobile Inv'rs v. Spratte, 605 P.2d 1151, 1152 (N.M. 1980)), and “oil and gas leases must be construed to give effect to all of their provisions so far as possible.” Owens v. Superior Oil Co., 730 P.2d 458, 460 (N.M. 1986) (citations omitted).

         When a contractual provision is in dispute, courts must first determine if the provision is ambiguous. “If a court concludes that there is no ambiguity, the words of the contract are to be given their ordinary and usual meaning[, ]” Lyons, 299 P.3d at 852 (quotation omitted), and the court “is limited to interpreting the contract which the parties made for themselves [as a court] may not alter or make a new agreement for the parties.” King, 215 F.Supp.3d at 1164 (quoting Lyons, 299 P.3d at 852). When contractual language is ambiguous, “the jury (or the court as the fact finder in the absence of a jury) resolves the ambiguity as ...


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