Hayes Fund Comes Undone

On December 8, 2015, the Louisiana Supreme Court tossed out the 3rd Circuit’s shocking award in Hayes Fund for First United Methodist Church of Welsh, LLC v. Kerr-McGee Rocky Mountain, LLC. Much to the dismay of many of us in the oil and gas community, the 3rd Circuit had reversed the district court’s ruling in favor of the oil and gas defendants to award the plaintiffs over $13 million in alleged lost revenues.  As the Supreme Court stated, this case presented a classic battle of experts that was resolved through factual findings and credibility determinations by the trier of fact.

The plaintiffs alleged that the defendants violated Mineral Code article 31:122 by mismanaging the operation of two wells and thereby causing the loss of hydrocarbons in the reservoir and thus a loss of royalties to the plaintiffs. Article 122 imposes a duty on a lessee to “develop and operate the property leased as a reasonably prudent operator for the benefit of himself [the lessee] and his lessor.”

Although the case was very fact intensive and a mountain of evidence was introduced over 25 days of testimony spread out over an 11 month period, the factual determination the district court had to make appears to have come down to whether (as the plaintiffs contended) the defendants’ cementing and other operations caused water to migrate into the reservoirs at issue and thus caused oil and gas in the reservoirs to become unrecoverable or instead whether (as the defendants contended) the reservoirs at issue were water-driven reservoirs. A water-driven reservoir is one where the expansion of the underlying water and rock already naturally in the reservoir forces oil and gas into the wellbore; when a reservoir is water-driven, it would be natural that the wells producing the reservoir would eventually water out as an expected matter of course.

The district court sided with the defendants’ experts and found that the plaintiffs had not proved by a preponderance of the evidence that any loss of hydrocarbons was caused by any imprudent operations of the defendants. But the Third Circuit reversed, finding that the district court was manifestly erroneous in its findings of fact in favor of defendants as to what caused the loss of royalties to the plaintiffs; rather than remanding the case to the district court to determine the amount of the plaintiffs’ damages, the Third Circuit also awarded $13,437,895 to the plaintiffs.  Although the defendants raised numerous separate grounds why the Third Circuit’s ruling deserved Supreme Court review, the Supreme Court concluded that the Third Circuit had erred in reversing the district court’s findings on causation; thus, the Court did not address the defendants’ other grounds for setting the Third Circuit’s ruling aside.

According to the Supreme Court, the Third Circuit misapplied the manifest error standard by essentially focusing on the testimony of the plaintiffs’ expert and the evidence supporting that testimony. The manifest error standard precludes an appellate court from setting aside a trial court’s finding of fact unless the finding is clearly wrong in light of the record reviewed in its entirety.  Put another way, the reviewing court must determine whether the trial court’s factual conclusion was a reasonable one—not whether it was right or wrong or whether a contrary conclusion might be reasonable.  After all, reasonable minds may differ.  As the Supreme Court explained, under a proper manifest error review, the reviewing court should focus on whether there was a clear error by the trial court because of a lack of a reasonable basis for the conclusion reached by said lower court.

The Supreme Court went through a fact intensive analysis of the evidence presented in the case and determined that the district court was not manifestly erroneous in determining that the defendants had not caused any lost production and thus any loss of royalty revenues to the plaintiffs. The Court determined that the district court’s finding that the water produced from one well and the upper zones of the second well was formation water because the reservoir was water driven was “clearly supported by the record evidence.”  Similarly, the Court determined that the evidence reasonably supported the district court’s finding that the plaintiffs failed to prove total reservoir destruction in the lower zones of the second well.  In sum, the Supreme Court found the district court’s “factual conclusions on causation are clearly and reasonably supported by the record, and therefore, the Third Circuit erred in its analysis of manifest error review.”

The Louisiana Supreme Court usually does not take a case simply to rule that a lower court got the facts wrong. So the typical Supreme Court opinion does not focus so much on the facts as it did in Hayes Fund.  Perhaps, the Court did so here because it wanted to emphasize the restricted scope of a manifest error review.  But perhaps, it was so that the Court could avoid addressing the defendants’ multiple other (and arguably more technical and industry-specific) reasons why the Third Circuit’s ruling was legally unsupportable.  Besides running roughshod over the district court’s findings on causation, its award also seemed to violate the collateral-attack doctrine by ignoring various findings of the Louisiana Commissioner of Conservation, to ignore controlling lease provisions and to rely on unsupported speculation by the plaintiffs and their expert.  Whatever the reason, it’s a big relief that the Supreme Court came to the rescue to toss out what could have become a dangerous and ill-founded precedent.

footer image footer image footer image