Texas Suspense Accounts One Year After Freeport

In a year dominated by the landmark cases Devon v. Sheppard and Van Dyke v. Navigator, the Texas Supreme Court's 2023 decision in Freeport-McMoRan v. 1776 Energy¹may tend to be overlooked.

Freeport is, however, a substantially important decision concerning two of the safe harbor provisions in section 91.402 of the Texas Natural Resources Code. Those allow the payment of proceeds to be withheld, i.e., placed in suspense, without interest when there is:

The facts of the Freeport case can be boiled down as follows:

• Ovintiv and 1776 were parties to joint operating agreements in Karnes County which required payment of proceeds from Ovintiv to 1776, with 1776 being billed by Ovintiv for its proportionate share of operating expenses.
• Separate to this relationship but covering the same assets, 1776 was sued by Longview Energy Company, alleging that two Longview directors acquired assets for 1776 when their fiduciary duties instead required them to acquire those assets for Longview.
• Longview won its lawsuit and the 1776 assets at issue were placed in a constructive trust.
• Once Ovintiv learned of the Longview judgment and the apparent question over 1776's entitlement to proceeds under the Ovintiv-1776 JOAs, Ovintiv placed 1776's proceeds under the JOA in suspense.³

1776 appealed the Longview judgment and ultimately won a reversal at the court of appeals, which was affirmed by the Texas Supreme Court. Ovintiv subsequently paid over the contents of the suspense account to 1776 without interest. 1776 claimed it was entitled to interest on these amounts because Ovintiv was not operating within section 91.402's safe harbors. 1776 lost this claim at the trial court and again at the Supreme Court.

Roadmap for Suspense Determination

The fact pattern that generated Freeport is admittedly complicated and unusual. But when reduced to its essential components, we simply see a dispute between purported payees and the withholding of proceeds without interest. Additionally, the two reasons provided by Ovintiv for placing the proceeds in suspense without interest are the two most commonly encountered: (i) a dispute concerning title and (ii) a reasonable doubt that the payee has clear title.⁴

The Freeport opinion provides a useful roadmap for resolving both these two conditions for withholding without interest.

Dispute Concerning Title

Section 91.402(b)(1)(A) requires the payor to establish two facts: (1) a "dispute concerning title" existed during the time it withheld production payments and (2) the dispute "would affect distribution of payments."

It was the second fact that was so heavily disputed in Freeport. The Supreme Court, relying on a plain language interpretation of "would affect distribution of payments," enunciated that the condition is present when the dispute causes "an expected future effect" on the distribution of payments.⁵ Neither a current effect nor a dispositive future effect are required.

In Freeport, 1776 might or might not have ultimately prevailed in the Longview lawsuit. It might or might not have been entitled to the proceeds held in suspense by Ovtiniv. Because of this, it was clear to the Court that the dispute would affect the distribution of payments, one way or the other.

Looking to more common circumstances, i.e., a dispute between royalty owners as to who owns an interest or over the quantum owned by each party, the questions for payors to ask are simply: (1) are there multiple possible outcomes to this title dispute, and (2) does the distribution of payment change depending on the outcome? If answered in the affirmative then, under Freeport, the condition of section 91.402(b)(1)(A) is met and the payor may withhold payments without interest.

Reasonable Doubt Regarding Clear Title

Section 91.402(b)(1)(B)(ii) requires "a reasonable doubt that the payee ... has clear title to the interest in the proceeds of production." On its face, one might interpret this to be coextensive with "a dispute concerning title that would affect distribution of payments."

First-grade geometry teaches us that all squares are rectangles but not all rectangles are squares. Similarly, there may be circumstances where, as in Freeport, the same facts support the conditions of both sections 91.402(b)(1)(A) and (B)(ii). But both the Legislature and Supreme Court do, and payors should, treat each subsection as a separate inquiry.

"Reasonable doubt" is a matter resolved objectively—that is, based on the sensitivities of an outside, reasonable person. Reasonableness inquiries may have underlying fact questions that need to be resolved before turning the question over to this objective, reasonable person. If there are no fact questions or if those questions draw but one rational inference, then reasonableness becomes a question of law for the court.⁶

The second part of the test is "clear title." The Supreme Court gives a fairly broad interpretation of what isn't clear title: (1) the existence of an underlying dispute which would cloud title and (2) that dispute is not frivolous.⁷ In Freeport, "the very existence of the underlying [Longview] dispute ... would cloud title[,]" and therefore "1776 Energy objectively could not have had 'clear title' ... and Ovtiniv, in turn, objectively held at least a 'reasonable doubt' regarding clear title."⁸

Other Holdings in Freeport

In reaching its decision, the Supreme Court made two additional holdings: one more helpful to lawyers and the other to payors' accountants and internal personnel.

The first discusses the length of time a "dispute" exists in the context of section 91.402 when it is a litigated matter. Litigation does not end until a judgment is "final" and a judgment does not become final until the last mandate is issued by the last appellate court hearing the matter. When a case is appealed all the way to the Supreme Court, the judgment is not final until the Supreme Court issues its mandate (as it was with the finality of the Longview judgment). The section 91.402 "dispute" thus lasts at least this long.

The second additional holding concerned whether Ovintiv could bill 1776 for its proportionate share of operating expenses while simultaneously placing 1776's proceeds in suspense, and whether this conduct affected Ovintiv's ability to withhold without interest under section 91.402. The Supreme Court held that Ovtiniv could continue to bill—"bills can be sent to an entity with clouded title"—and that billing did not prevent Ovintiv from continuing to withhold without interest.

Quick Reference Chart

The chart below is designed for quick reference for withholding without interest under sections 91.402(b)(1)(A) and (B)(ii), but should not be used as a substitute for a full factual and legal analysis.

Footnotes

1. Freeport-McMoRan Oil & Gas LLC v. 1776 Energy Partners, LLC, 672 S.W.3d 391 (Tex. 2023).

2. Tex. Nat. Res. Code §§ 91.402(b)(1)(A)-(B).

3. Freeport, 672 S.W.3d at 394-95.

4. There are other reasons a payor may withhold proceeds without interest under section Natural
Resources Code §§ 91.402(b)(1)(C) (“a requirement in a title opinion that places in issue the title,
identity, or whereabouts of the payee and that has not been satisfied by the payee after a
reasonable request for curative information has been made by the payor”) and 91.402(b)(2) (“the
payments are subject to a child support lien under Chapter 157, Family Code, or an order or writ
of withholding issued under Chapter 158, Family Code”).

5. Freeport, 672 S.W.3d at 397.

6. Freeport, 672 S.W.3d at 399.

7. Freeport, 672 S.W.3d at 400 (cleaned up).

8. Id.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.