SUMMARY: On cross-motions for summary judgment, the federal district court for the Western District of Texas held that under this lease an underpayment of royalty was a “nonpayment” within the meaning of a clause that allowed for potential lease termination. However, it also held the lessor’s notice had to identify the specific nonpayment, which a general refund demand did not. The court further held that a clause indicating royalties must be free of deduction for “any other costs of whatsoever nature,” did not require the lessee to add back transportation and fractionation adjustments that NGL purchasers built into their index-based price, distinguishing the language from that in Devon v. Sheppard.
YMC Royalty Co. LP leased its Section 9 interest in Loving County to RKI Exploration & Production, LLC in 2016 for a 25% royalty, and RKI assigned the lease to WPX Energy Permian, LLC in 2019. Under the royalty clause, the lessor could give “written notice of nonpayment of royalty” and, if the royalty “is not paid on or before expiration of thirty (30) days” from the notice, “may terminate this Lease.”
In 2021, WPX deducted from YMC’s royalty a gathering fee that WPX attributes to an accounting error. On December 3, 2021, YMC demanded a refund of all deductions since the lease began and wrote that the lease “will terminate in 30 days from this notice date unless WPX complies with its express obligations under the Lease.” WPX refunded that fee category in December and asked YMC to identify any other deductions. YMC sued in March 2024, claiming the lease had terminated because WPX had not paid royalty on plant fuel and flared gas and had made improper deductions on NGLs.
WPX argued that only an uncured “nonpayment” could trigger the clause, not an “underpayment.” Reading “royalty” and “nonpayment” by their ordinary definitions, the court held that under this lease an underpayment “necessarily constitutes a nonpayment” because the underpaid lessor does not receive its share of production. The court found WPX’s reading unreasonable because it added terms to the lease, so the rule favoring a reading that avoids forfeiture did not apply.
YMC contended that its December 3 letter “literally complied” with the clause, and WPX responded that it identified only the refunded fee category. The court sided with WPX. Relying on the rule, from Reilly v. Rangers Mgmt., Inc., 727 S.W.2d 527 (Tex. 1987), that courts “will not declare a forfeiture unless they are compelled to do so,” the court construed this lease’s notice provision to require notice of “the specific way or ways in which the lessee breached the lease.” It agreed with WPX that the audit clause in the same section confirmed that a general demand would not do. Under YMC’s reading, the court explained, a lessor could send a general notice, find an underpayment years later, “whether that underpayment is for $1,000,000 or $1,” and claim a termination dating back to 30 days after the original notice. Because the December 3 letter identified no uncured nonpayment, the court held that it did not trigger termination.
The court distinguished Coastal Oil & Gas Corp. v. Roberts, 28 S.W.3d 759 (Tex. App.—Corpus Christi 2000, pet. granted, judgm’t set aside), on which YMC relied, on its facts and because that lease required only a “written demand of payment.” The court dismissed YMC’s termination-based claims, including a claim for more than $18 million under the lease’s $50-per-acre-per-day surrender clause.
The gas royalty was 25% of “the amount realized from the sale thereof and any products produced therefrom to the first purchaser that is not affiliated with or related to Lessee,” and the lease barred deductions for listed costs “or any other costs of whatsoever nature.” The processor sold the NGLs to unaffiliated purchasers at a Mont Belvieu index price reduced by formula adjustments for the purchasers’ possible transportation and fractionation costs. YMC argued that those adjustments were prohibited deductions. The court disagreed. It reasoned that this “amount realized” lease was valued at the point of sale, that no-deductions language this broad has been treated as surplusage that does not reach post-sale costs, and that the adjustments were post-sale costs built into the price. The lease had no “add-on” provision like the one in Devon Energy Prod. Co. v. Sheppard, 668 S.W.3d 332 (Tex. 2023), which required price reductions for post-production costs to be “added to” gross proceeds.
WPX admitted that it paid no royalty on plant fuel, but argued there was no breach because it had overpaid the oil royalty. The lease made the oil royalty an in-kind royalty “to be delivered at the wells,” yet WPX paid YMC for more than five years without deducting post-production costs, which its expert put at $2,190,812.61. The court held that an overpayment of one royalty does not negate the failure to pay another, so WPX breached the lease. But the court denied YMC summary judgment on damages. It reasoned that if YMC had made no arrangement to take or store its oil, and the parties had no other arrangement, WPX would be authorized to sell the oil for YMC and deduct post-production costs. Because the record did not establish those facts, whether YMC was overpaid and whether it suffered recoverable damages remain for trial.
On “nonpayment,” the court refused to add terms to the clause. On “notice,” it found a specificity requirement that the clause does not spell out, relying on the audit clause and the disfavor of forfeitures. The anti-forfeiture rule may explain the difference: the court found WPX’s reading of “nonpayment” unreasonable, but it did not find YMC’s reading of “notice” compelled. The court’s example of a general notice reaching back years to a later-discovered $1 shortfall also traces to the clause, which did not say what a notice had to contain or how long it stayed effective.