THE ANDERSON LIVING TRUST, f/k/a The James H. Anderson Living Trust; THE PRITCHETT LIVING TRUST; J. RICHIE FIELDS; THE TATUM LIVING TRUST; NEELY-ROBERTSON REVOCABLE FAMILY TRUST, Plaintiffs - Appellants,
ENERGEN RESOURCES CORPORATION, Defendant-Appellee.
from the United States District Court for the District of New
Mexico (D.C. No. 1: 13-CV-00909-WJ-CG) (D. N.M.)
Bradley D. Brickell, Brickell & Associates, P.C., Norman,
Oklahoma (Margaret M. Branch and Cynthia L. Zedalis, Branch
Law Firm, Albuquerque, New Mexico, Karen Aubrey, Law Office
of Karen Aubrey, Santa Fe, New Mexico, and Brian K. Branch,
Law Office of Brian K. Branch, Albuquerque, New Mexico, with
him on the briefs), for Appellants.
Christopher A. Chrisman, Holland & Hart LLP, Denver,
Colorado (Bradford C. Berge, Holland & Hart LLP, Santa
Fe, New Mexico, and Jessica M. Schmidt, Holland & Hart
LLP, Denver, Colorado, with him on the brief), for Appellee.
TYMKOVICH, Chief Judge, HARTZ, and O'BRIEN, Circuit
the Anderson Living Trust, the Pritchett Living Trust, the
Neely-Robertson Revocable Family Trust, and the Tatum Living
Trust (collectively the Trusts), and Appellee, Energen
Resources Corporation, have petitioned for panel rehearing.
Neither party has requested en banc review. Both parties have
filed responses to the other's petition. The Trusts have
filed a motion for leave to file a reply.
Trusts' petition for panel rehearing is
GRANTED to the extent we have removed
footnote 19 from the opinion filed on January 9, 2018, which
was unopposed. Their petition is DENIED in
all other respects. We have considered the Trusts' reply
and GRANT their motion for leave to file it.
The Clerk is directed to show it filed on the docket
effective the date of this order.
petition for panel rehearing is GRANTED to
the extent we have clarified in the, that Energen does not
market (sell) the gas it produces on the leased properties at
the wellhead. The changes are reflected on pages 7 and 8 of
the revised Opinion.
Clerk is directed to file the attached revised Opinion
effective the date of this order.
O'BRIEN, CIRCUIT JUDGE.
fuels are the decomposed remains of pre-historic flora (coal)
and fauna (oil and gas). They have driven the world's
economy (particularly that of the United States) for over a
century. Discovering marketable deposits, extracting them
from the ground, refining them, and delivering them to
consumers in useful form is big business, on one hand fraught
with risk and on the other richly rewarding. That being so,
it has attracted the attention of governments as a lucrative
source of tax revenue as well as royalties, bonuses, etc.,
derived from government-owned reserves and as a way of
directing public policy. Since oil and gas are the most
energy dense and convenient of the fossil fuels,
litigation and regulation abound with respect to them. But,
in large measure mineral owners (private and public) and
those involved with mineral producers have been free to
contractually "strike their own deals." Myriad
matters are involved; here we are principally concerned with
construing the language of leases in accordance with
prevailing law-both statutes and case law. Statutes, of
course, properly direct policy. So do cases, more covertly,
but no less dramatically.
gas law is rife with duties owed by the lessee to the lessor.
Some of those duties are expressed in an agreement (the
lease). Others duties are imposed by the courts as implied
covenants. See generally, 6 Peter Linzer, Corbin on
Contracts § 26.1 (Joseph M. Perillo ed. 2010). This case
involves the implied covenant to market gas. It benefits the
lessor, in particular, by insuring that the lessee uses
reasonable efforts to market potential production. That way
the lessor can enjoy the benefits the lease provides. This
case deals with that implied covenant, but more particularly
with what has come to be known as the marketable condition
rule. In its purest form, that advocated by appellants, it
not only requires the lessor to market the gas, but to do so
solely at its expense. Colorado has adopted a version of the
marketable condition rule, which applies only when the lease
does not provide otherwise. Years ago we predicted New Mexico
would not adopt the marketable condition rule and so far
neither the legislature nor the New Mexico Supreme Court has
done so. Accordingly, our decision rests on the terms of the
leases involved. We rely on the text of the leases and the
meaning commonly ascribed to the language used (the essence
of the common law, which reflects the practices of the
community, rather than dictates practices to the community).
Juan Basin, located in northwestern New Mexico and southern
Colorado, is a rich source of oil and natural gas. Energen
owns and operates oil and gas wells in the
Basin. Its wells are subject to leases and other
agreements (many of which are quite old) requiring it to pay
a monthly royalty or overriding royalty on production to
the Anderson Living Trust, the Pritchett Living Trust, the
Neely-Robertson Revocable Family Trust (N-R Trust), and the
Tatum Living Trust. The royalty interests of the Anderson,
Pritchett, and N-R Trusts (collectively the New Mexico
Trusts) derive from wells located in New Mexico, the Tatum
Trust's royalty interest from wells located in Colorado.
Energen was systematically underpaying royalties, all of the
Trusts filed a putative class action complaint against
The New Mexico Trusts claimed Energen was improperly
deducting from their royalties their proportionate share of
(1) the costs it incurs to place the gas produced from the
wells in a marketable condition (post-production costs) and
(2) a privilege tax the State of New Mexico imposes on
natural gas processors (the natural gas processors tax). They
also alleged Energen had not timely paid royalties or
interest thereon, as required by the New Mexico Oil and Gas
Proceeds Payments Act. Both the New Mexico Trusts and the
Tatum Trust further claimed Energen was wrongfully failing to
pay royalty on the gas it used as fuel.
district judge dismissed the New Mexico Trusts'
marketable condition rule claim for failure to state a claim
under Fed.R.Civ.P. 12(b)(6) and entered summary judgment in
favor of Energen on the remaining claims. All of the Trusts
appeal from those judgments. Our review is de novo. Birch
v. Polaris Indus., Inc., 812 F.3d 1238, 1251 (10th Cir.
2015) (grant of summary judgment is reviewed de novo);
Thomas v. Kaven, 765 F.3d 1183, 1190 (10th Cir.
2014) (grant of motion to dismiss under Fed.R.Civ.P. 12(b)(6)
is reviewed de novo).
most part we agree with the district judge, particularly in
the following respects:
under New Mexico law, Energen had the duty to diligently
market the gas for the benefit of the New Mexico Trusts but
that duty did not prohibit it from deducting from
their royalty payments their proportionate share of
post-production costs-those costs necessary to make the gas
marketable (i.e., the marketable condition rule does not
apply in New Mexico).
nothing in the New Mexico Natural Gas Processors Tax Act or
other New Mexico law prohibited Energen from deducting the
Trusts' proportionate share of the tax from their
the Anderson and Pritchett Trusts' lease allows Energen
to use produced gas as fuel without paying royalty on it.
respects, we part ways with him. They relate to: (1) the fuel
gas claims made by the N-R Trust and Tatum Trust and (2) the
New Mexico Trusts' claim under the New Mexico Oil and Gas
Proceeds Payments Act. As to the former, the N-R Trust's
overriding royalty agreement requires royalty to be paid on
all gas produced, including that gas used as fuel. And the
Tatum Trust's leases explicitly prohibit Energen from
deducting post-production costs (Energen treats its use of
the fuel gas as an in-kind post-production cost). Moreover,
the "free use" clauses and royalty provisions in
the Tatum Trust's leases limit the free use of gas to
that occurring on the leased premises. Because use of the
fuel gas occurs off the leased premises, Energen owes royalty
on that gas. With regard to the latter, the judge was right
in permitting Energen to hold funds owed to the N-R Trust in
a suspense account until a title issue concerning a well was
resolved in favor of that Trust. However, he did not address
whether the N-R Trust was entitled to statutory interest on
those funds. It was so entitled, yet the current record (at
least as we read it) does not show interest to have been paid
on the funds.
explain. Because all claims do not apply to all appellants,
we discuss the issues separately, providing a brief
background of the facts relevant to each.
Marketable Condition Rule-New Mexico Trusts
produced from Energen's wells on the leased
properties is not marketed (sold) at the wellhead.
See 8 Howard R. Williams & Charles J. Meyers,
Oil and Gas Law, at 830 (2011) (defining
"[p]roduction of gas" as "[t]he act of
bringing forth gas from the earth"). It is first
gathered, compressed, dehydrated, and treated. Energen contracts
with third-party companies to perform these services. It then
sells the processed gas at the tailgate of the
third-party processing plants to various energy companies.
pays the New Mexico Trusts, as royalty, a portion of the
downstream sales price. However, it deducts from that price
each Trust's proportionate share of the fees it pays to
third-party companies to make the gas marketable
Mexico Trusts claim this deduction is improper because, in
their words, New Mexico law imposes an implied duty on
Energen to market the gas for the benefit of the royalty
owners and that duty necessarily prohibits Energen from
deducting post-production costs from their royalty payments
(generally referred to as the marketable condition
Mexico Trusts' leases set the basis for royalty payments
as the "market value at the well" or the
"prevailing field market price." (Appellants'
App'x at 342 (N-R Trust), 338 (Anderson and Pritchett
Trusts).) Determining those amounts, however, is not
straightforward, because Energen does not sell the gas it
produces on these leased properties "at the well."
As we explained in Abraham v. BP America Production
In order to determine the market value of the unprocessed gas
at the well, producers sell refined natural gas and NGLs
[natural gas liquids] at the tailgate of the processing plant
(i.e., after processing) to establish a base sales amount,
and deduct from that amount costs for transportation,
processing, etc. This is called a "netback" or
"workback" method, and it is widely accepted as the
best means for estimating the market value of gas at the well
where no such market exists.
685 F.3d 1196, 1200 (10th Cir. 2012).
understood, the netback method is not a means of
cost-shifting; it is a means of determining the net profit on
the oil and gas by "netting" the gross profit. The
post-production expenses are not subtracted from the sales
amount because the royalty owners are responsible for
post-production expenses; they are subtracted as an
accounting mechanism to determine the market value at the
wellhead. Stated differently, "value added" to the
gas produced at the wellhead solely through the effort and
expense of the lessee must be deducted from an established
market price of the improved product in order to make an
accurate estimate of the value of the gas at the wellhead. In
simple terms, if [A] the market value at the wellhead [B]
the value added in the production process (post-production
costs) = [C] the value of the processed natural
gas (the sales price of the processed gas), then [C] - [B] =
[A]. Subtracting [B] does not shift some of the costs of
production to the lessors; it is an accounting adjustment
designed to effectuate the intention of the parties as it is
expressed in the parties' agreement-the lease. The Fifth
Circuit explained this rationale years ago:
[I]n the analytical process of reconstructing a market value
where none otherwise exists with sufficient definiteness, all
increase in the ultimate sales value attributable to the
expenses incurred in transporting and processing the
commodity must be deducted. The royalty owner shares only in
what is left over, whether stated in terms of cash or an end
product. In this sense he bears his proportionate part of
that cost, but not because the obligation (or expense) of
production rests on him. Rather, it is because that is the
way in which [one] arrives at the value of the gas at the
moment it seeks to escape from the wellhead.
Freeland v. Sun Oil Co., 277 F.2d 154, 159 (5th Cir.
recap: It is incorrect to assert, as the Trusts do, that
royalty owners are "bearing post-production costs."
They are not. With that matter now settled, we press
on to the marketable condition rule.
New Mexico Has Not Adopted the Marketable Condition
will explain, the New Mexico Supreme Court has decided oil
and gas well operators have a duty to market the gas for the
benefit of the royalty owners and that duty is one implied as
a matter of law (irrespective of the parties' agreement).
See Davis v. Devon Energy Corp., 218 P.3d 75, 86
(N.M. 2009). However, it has yet to decide whether that duty
includes the marketable condition rule. Normally, in
such circumstances, we would attempt to predict what that
Court would do. Coll v. First Am. Title Ins. Co.,
642 F.3d 876, 886 (10th Cir. 2011). However, "when a
panel of this Court has rendered a decision interpreting
state law, that interpretation is binding on district courts
in this circuit, and on subsequent panels of this Court,
unless an intervening decision of the state's
highest court has resolved the issue." Wankier
v. Crown Equip. Corp., 353 F.3d 862, 866 (10th
Cir. 2003) (emphasis added).
district judge decided the issue was put to rest in
Elliott Indus. Ltd. P'ship v. BP Am. Prod.
Co., 407 F.3d 1091 (10th Cir. 2005). Energen argues we
are obligated to honor Elliott's holding. We
Elliott Decides the Issue
Elliott, the royalty agreement required the well
operators to pay Elliott Industries a royalty on the
"'market value of the gas at the well.'"
407 F.3d at 1100. To establish that value, the operators
deducted their post-production costs from the downstream
sales price, including 39% of the natural gas liquids, which
the operators retained as an in-kind fee for their processing
services (i.e., the netback or workback method, see
supra at 8-10). Id. Elliott objected to the 39%
in-kind deduction, arguing, among other things, it was not a
legitimate post-production cost and its deduction results in
an underpayment of royalty. Id. at 1100, 1107. It
claimed the operators had an implied duty to market the gas,
which also prohibited them from deducting post-production
costs from the royalty payment. Id. at 1113. We
concluded the operators had complied with the implied duty to
market under New Mexico law-they were actively producing gas,
processing it, and selling the refined natural gas and
natural gas liquids. Id. (citing Darr v.
Eldridge, 346 P.2d 1041, 1044 (N.M. 1959) (the implied
duty to market requires oil and gas well operators/lessees
"to make diligent efforts to market the production in
order that the lessor may realize on his royalty
interest.") (quotation marks omitted)).
(like the New Mexico Trusts here) claimed the implied duty to
market included the marketable condition rule, which
prohibited the operators from deducting the costs necessary
to make the product marketable, including the cost of
removing the natural gas liquids from the gas, in calculating
the value of the gas at the wellhead under the netback
method. Id. at 1113-14. Not so, we said:
"This conception of the implied duty to market finds
no support within New Mexico case law."
Id. at 1114 (emphasis added).
the New Mexico Trusts acknowledge Elliott, they
provide a host of technical reasons why we should ignore it.
Energen, of course, presents contrary arguments. That
particular debate may seem arcane and the arguments tedious,
but the discussion is necessary. So, as some residents of the
Tenth Circuit might say: Saddle up!
Mexico Trusts tell us Elliott's discussion of
the marketable condition rule is dicta. According to
them, the panel had already decided the implied duty to
market claim failed because Elliott had dismissed its claim
for breach of the royalty agreement. They are incorrect, both
factually and legally.
did not dismiss its breach of contract claim; it never
brought one. 407 F.3d at 1107 ("Elliott . . . has never
asserted an unequivocal and straight-forward contract claim
alleging a breach of [the operators'] express obligations
to pay royalties. In fact, Elliott steadfastly disclaims any
cause of action for breach of an express contract.").
Our discussion of the marketable condition rule was not
of raising a breach of contract claim, Elliott relied on the
implied duty to market, claiming that duty should govern
because the contract did not specifically address the 39%
in-kind processing fee. Id. at 1111. According to
Elliott, that duty prohibited the operators from deducting
from the royalty payment the cost of removing the natural gas
liquids from the gas. Id. at 1107-08, 1113. We
rejected that argument on two grounds.
Elliott could not show that an implied duty to market existed
in that case because other than asserting that the royalty
agreement did not address the 39% processing charge, it did
not otherwise rely on the agreement. Id. at 1113.
Without the agreement, we could not determine "whether
any implied duty to market was intended by the parties or
would contradict the express provisions of that agreement . .
. . This court cannot speculate as to what [the agreement]
contain[s] or how to construe the scope of any implied
covenant to market that may exist." Id. (citing
Cont'l Potash, Inc. v. Freeport-McMoran, Inc.,
858 P.2d 66, 80 (N.M. 1993)).
even ignoring Elliott's "strategic choice" not
to rely on the express terms of the royalty agreement, the
implied duty to market claim "still fail[ed]."
Id. Elliott tried to use the implied duty to
supplement the express provisions of the agreement, including
the "at the well" language. Id. Doing so
was improper, we said, because "under New Mexico law,
covenants are not implied for subjects that are treated in
express provisions." Id. (citing Cont'l
Potash, Inc., 858 P.2d at 80). Moreover, the operators
were actively marketing the gas and New Mexico law did not
support the applicability of the marketable condition rule.
Id. at 1113-14.
rejection of the marketable condition rule constituted an
alternative rationale for rejecting Elliott's implied
duty to market claim. "Alternative rationales, . . .
providing as they do further grounds for the Court's
disposition, ordinarily cannot be written off as
dicta." See Surefoot LC v. Sure Foot
Corp., 531 F.3d 1236, 1243 (10th Cir. 2008); see
also United States v. Rohde, 159 F.3d 1298, 1302 (10th
Cir. 1998) (alternative holdings are not dicta).
we could have resolved Elliott's implied duty to market
claim without reaching the applicability of the marketable
condition rule. However, we could have also decided the claim
solely by rejecting the marketable condition rule. The New
Mexico Trusts have not explained why we ought label the
latter dicta, but not the former. See Rohde, 159
F.3d at 1302 n.5 (10th Cir. 1998) ("Were this panel
inclined to engage in the business of labeling as
dicta one of the two alternative grounds . . ., it
would then confront defendant's failure to demonstrate
why that label ought not adhere to the alternative which is
innocuous to her theory, rather than to the alternative which
Reliance on Continental Potash
Mexico Trusts also attack Elliott for relying on
Continental Potash, Inc. v. Freeport-McMoran, Inc.,
858 P.2d 66 (N.M. 1993), which they say was subsequently
limited by Davis, 218 P.3d 75. For what it's
worth, we agree with their reading of Davis; but it
doesn't help them.
Continental Potash, the New Mexico Supreme Court
said covenants will not be implied on contracting parties
when the issue is expressly covered in the parties'
agreement. 858 P.2d at 80 ("The general rule is that an
implied covenant cannot co-exist with express covenants that
specifically cover the same subject matter"; "when
the contract between the parties speaks to the obligation
sought to be implied, courts will not write that implied
obligation into the contract."). However, in
Davis, the Court clarified that Continental
Potash was speaking only to those covenants
"implied in fact, " i.e., those implied based on
the language of the parties' agreements. 218 P.3d at 85.
Not surprisingly, covenants implied in fact require analyzing
the parties' intentions as expressed in their agreement.
Id. But, as Davis makes clear, there are
also covenants implied as a matter of law. Id.
Duties implied by law apply to the parties irrespective of
the language of their agreement. Id. Davis
said the implied duty to market falls in the latter category.
Id. at 86. It thus undermines Elliott, but
only in part.
Elliott panel relied on Continental Potash
as one basis for rejecting Elliott's implied duty to
market claim-it could not determine whether an implied duty
to market existed without knowing from the royalty agreement
whether such duty was intended, nor could Elliott use the
duty to supplement the royalty agreement's terms because
covenants are not implied for subjects expressly treated in
an agreement. Elliott, 407 F.3d at 1113.
Davis, however, said the implied duty to market is
one implied by law, which does not require analysis of the
parties' agreement and applies notwithstanding that
Davis does not undermine Elliott's
decision that the marketable condition rule finds no support
in New Mexico law because, semantics aside, the
Davis Court explicitly declined to decide that
issue, finding it not ripe for review. Id. at 80-81
("[W]e do not address the existence of the marketable
condition rule in New Mexico . . . . [N]othing in this
opinion should be construed as either the recognition or
disapproval of the marketable condition rule, its scope, or
its applicability."). It assumed the marketable
condition rule applied in New Mexico only because the trial
judge concluded it did. Id. at 80. Even more to the
point, the New Mexico Supreme Court subsequently clarified:
"[I]n Davis we declined to address whether the
marketable condition rule is inherent in the implied covenant
to market, and whether, if recognized in New Mexico, the
marketable condition rule would be implied in fact or at
law." ConocoPhillips Co. v. Lyons (Lyons), 299
P.3d 844, 860 (N.M. 2012) (citation omitted).
that fairly clear statement, the New Mexico Trusts
nevertheless tell us the Davis Court implicitly
imposed the marketable condition rule on New Mexico.
According to the Trusts, the Davis Court surely
would have recognized the extreme waste of judicial resources
that would occur for it to grant class certification in that
appeal based on the trial judge's adoption of the
marketable condition rule only to later say in a second
appeal that the marketable condition rule does not exist in