Washout of Production Payments Upon Expiration of the Underlying Leasehold
The Texas Supreme Court, in Apache Deepwater, LLC v. McDaniel Partners, Ltd., No. 14-0546, 2016 Tex. LEXIS 179 (February 26, 2016), addressed the issue of the calculation of production payments reserved in the assignment of four oil and gas leaseholds, and whether, after two of the leases terminated, the production payment should be adjusted to reflect the loss of the two leaseholds.
To determine which percentage should be used to calculate the production payment, the Supreme Court examined whether the intent of the assignment was to convey a fixed production payment or whether the assignment intended for the production payment to be proportionately adjusted based an individual lease’s expiration. Id., at *7-8. McDaniels argued that because the equation stated the production payment as a percentage of the cumulative working interest conveyed and it is used throughout the agreement, it was indicative of the parties’ intent to burden the individual leases jointly with a production payment based upon the original, cumulative working interest conveyed (35/64). Id. On the other hand, Apache contends that the production payment was to be a fraction of the working interest owned in each of the leases.
The Supreme Court analyzed the production payment as though it were an overriding royalty interest and explained that “[w]hen . . . the production payment is carved from the lessee’s working interest, it is like an overriding-royalty interest, except for its more limited duration.” Id., at *12. In the case of a single lease, a production payment would not survive the expiration of the underlying lease and the Supreme Court applied the same rationale when analyzing the assignment of multiple leases. Id. Thus, the Supreme Court concluded that the production payment as to the expired leases owned by McDaniels terminated upon the expiration of the underlying leases. The Supreme Court noted that Ferguson Assignment did not include any savings clause or other language to allocate the burden of the production payment to the surviving leases. Accordingly, under the Texas Supreme Court’s decision in Apache Deepwater, a production payment terminates upon expiration of the underlying lease. However, Apache Deepwater implied that a production payment may survive expiration of the underlying lease with an appropriate savings clause.