A recent decision by the New Mexico Supreme Court is important for all oil and gas companies operating in New Mexico, and also offers an important lesson for royalty interest owners across the country.  In The First Baptist Church of Roswell v. Yates Petroleum Corp., the Court ruled that the royalty owner was entitled to interest on monies held in a suspense account based on a state statute, despite a contractual agreement between the parties to the contrary.  [To read the full opinion, click here.]

Background

The plaintiffs represent a class of persons who own royalty interests in a well in Eddy County, New Mexico, that is operated by the defendant.  Once the well was drilled and proceeds generated, the defendant mailed a division order to each of the royalty owners for signature.  Division orders are used in the oil and gas industry to ensure payment to property royalty owners.  These orders generally set forth all interests (royalty, overriding royalty, and working interest) in a specific well and assign a percentage ownership to each interest owner.  Once the royalty owner confirms the information is correct and signs the order, the oil and gas company will pay the royalty owner his or her share of the proceeds based upon the information in the division order.   [Read more about division orders here.]

Defendants sent out division orders to those owning interests in the well at issue.  In addition to listing the percentage ownership of each party, the division order form included a provision stating that in the event that a party failed to provide marketable title, the defendant “is authorized to withhold payments without payment of interest until the claim is settled.” (Emphasis added).  The plaintiffs signed the division orders in June 2003.  Three years later, the defendants sent initial royalty payments to the plaintiffs without including any interest.  Plaintiffs filed suit claiming they were entitled to interest on these payments pursuant to the New Mexico Oil and Gas Proceeds Payment Act (NMPPA).

New Mexico Law

Under the NMPPA, royalty payments must be paid within 6 months or shall be placed into a suspense account until the rightful payee is determined.  See NMSA 1978, Section 70-10-3.  In this case, defendants complied with this requirement, placing royalty proceeds into a suspense account until division orders were signed and title requirements were satisfied.  The NMPPA goes on to state that “in instances where payment cannot be made within the time period provided [under the NMPPA], the payor shall create a suspense account on his or her books for such interest or may interplead the suspended funds into court.  The person entitled to payment from the suspended funds shall be entitled to interest on the suspended funds from the date payment is due under [the NMPPA.].”  NMSA 1978, Section 70-10-4 (emphasis added).

Court Rulings

The trial court found in favor of the defendants, holding that the NMPPA unambiguously requires payment of interest on funds held in suspense and expresses a strong public policy in favor of royalty owners.  The court reasoned that the defendant’s division order form, where royalty owners forego interest, violates that public policy and is unenforceable.  Thus, the court determined the plaintiffs were entitled to interest payments.  The defendants appealed the decision.

The New Mexico Court of Appeals reversed the trial court.  See 2012-NMCA-064.  The court of appeals reasoned that the mere fact the Legislature enacted a statute providing a benefit does not indicate the Legislative intent to outweigh the parties’ right to freedom of contract.  Thus, the court found the parties were free to contract away the interest proceeds at issue and found for the defendant.  The plaintiffs appealed the decision.

The New Mexico Supreme Court sided with the plaintiffs and affirmed the trial court’s decision.  Specifically, the court found that the NMPPA evidences a “strong public policy in favor of establishing the rights of royalty owners.”  Further, the Legislature “unequivocally established the basic terms by which oil and gas proceeds are to be paid” in light of the “disparity in bargaining power” between oil and gas companies and royalty interest owners.  Thus, the court held that NMPPA Section 70-10-4 “expresses a clear public policy in favor of Petitioners’ right to interest on funds to which they are entitled, and this statutory provision cannot be contracted around.”

What Can We Learn?

First, oil and gas companies operating in New Mexico should be aware of this decision and understand that even if parties purport to contract away their rights under the NMPPA, the provisions of the Act may still apply.  This is clearly true with regard to the payment of interest on funds held in a suspense account.  This may mean that oil and gas companies need to alter practices that are inconsistent with the NMPPA in order to avoid disputes with interest owners.

Second, and more generally applicable to all royalty interest owners even outside New Mexico, is the lesson that division orders must be read very carefully.  It is not uncommon for a division order to contain terms modifying the agreement between the parties, as was the case here.  When royalty owners receive a division order, they should review it carefully to ensure that their percentage ownership is recorded correctly, but also to ensure they are not making additional contractual agreements to which the royalty owner might object.  If the royalty owner does object to certain terms, he or she should address those terms before signing the division order.  As noted in the opinion, the language forfeiting interest payments found in the division order at issue was removed from the division orders of certain royalty interest owners who objected to that term.  Because these issues are complex, I highly recommend that when negotiating an oil and gas lease and evaluating a division order, royalty owners seek counsel from an experienced oil and gas attorney in their state.