The Louisiana Second Circuit Court of Appeal, in Middleton, et al. v. EP Energy E&P Company, L.P., et al., concluded that, in considering whether mineral leases terminated for failure to produce in paying quantities, a fact finder may consider periods of production years prior to filing suit, but must consider all factors which would influence a reasonably prudent operator to continue production, and at the summary judgment stage, cannot simply emphasize certain relevant evidence and disregard other evidence in this determination. In doing so, the Second Circuit affirmed in part and reversed in part the lower court’s ruling granting a motion for partial summary judgment in favor of plaintiffs-lessors terminating three mineral leases for failure to produce in paying quantities, and remanded to the district court for further proceedings.
In Middleton, plaintiffs, the successors to the original lessors, filed suit against defendants-oil and gas companies who had an interest in maintaining the three mineral leases, arguing that the three leases terminated on their own terms for failure to produce in paying quantities during a period of forty-one months approximately 17 years prior to filing suit. The lower court agreed with the plaintiffs, finding that, even if it were to consider the profit calculations put forth by the defendants, the unitized well holding the leases averaged a profit of just over $70 a month, and this minimal profit was not “sufficient to induce a reasonably prudent operator to continue production.” The lower court thus granted the plaintiffs’ motion for partial summary judgment, and ordered that the leases terminated by their own terms during this 41-month period.
On appeal to the Second Circuit, the defendants argued the lower court erred in considering a period of production that occurred 17 years prior to the filing of plaintiffs’ suit and in ignoring the following 17 years of production. The Second Circuit rejected that argument, finding prior authority under Louisiana law that considered periods of production years prior to filing suit supported the plaintiffs’ position, and concluding that defendants had not shown that the lower court was required to consider the well’s production in the subsequent 17 years.
The Second Circuit next turned to defendants’ second argument: the lower court erred in finding the unitized well failed to produce in paying quantities as the evidence demonstrated that a reasonably prudent operator would have continued production. The appellate court noted that it was the plaintiffs’/lessors’ burden of demonstrating cancellation of the leases, and recognized that the standard to be applied in determining whether the well produced in paying quantities is “whether or not under all the relevant circumstances a reasonably prudent operator would, for the purpose of making a profit, continue to operate a well in the manner in which the well in question was operated.” The Second Circuit also recognized that the term “paying quantities” implies that production income exceeds operating expenses.
Turning to the evidence presented by both plaintiffs and defendants, the appellate court noted that although the plaintiffs introduced evidence that expenses exceeded revenue during the time period at issue, defendants had produced the affidavit of a petroleum engineer who testified to the following: (1) the expenses included extraordinary expenses; (2) the average monthly profit excluding these extraordinary expenses was over $70; and (3) because a workover increased production, an operator could reasonably assume that the extraordinary expenses incurred during the workover could be recouped from continued production. The appellate court first noted that extraordinary, nonrecurring expenses should not be considered in a determination of production in paying quantities, and also found that the lower court had improperly disregarded evidence demonstrating another well in the same formation was producing successfully and that the well at issue had increased production. The Second Circuit concluded that defendants’ evidence was sufficient to create a material issue of fact, after considering all factors which would influence a reasonably prudent operator to continue production, including the market price available, the relative profitability of other nearby wells, the operating costs, the net income, and the reasonableness of the expectation of profit. The court thus reversed the part of the judgment granting the plaintiffs’ motion for partial summary judgment and terminating the mineral leases.
The Middleton decision indicates that in determining whether a lease terminated for failure to produce in paying quantities, the factfinder may consider production periods even years prior to the filing of suit, and is not required to consider subsequent years of production. Moreover, the decision demonstrates that the factfinder must consider all relevant evidence – not just profit realized, and must not, at least at the summary judgment stage, give more weight to certain evidence. A copy of the Second Circuit’s decision can be found here. For more information regarding the decision, please contact Rob McNeal at rbmcneal@liskow.com or Erin Bambrick at ebambrick@liskow.com.