Mineral Royalty Mispayments: The Payor’s Right of Recoupment
by Douglas R. Hafer and Daniel B. Mathis
At some point, every oil and gas company (payor) will have to address a royalty mispayment. Due to the volume and complexity of royalty calculations—which often involve cumbersome decimal and fractional interests—mispayments caused by clerical errors, computer glitches or other mistakes are inevitable. The resulting mispayments can be underpayments, overpayments, or both. While a scrupulous payee often detects an underpayment soon after it occurs, an overpayment may go undetected or unreported for years (no one wants to think they have been overpaid). Regardless of which occurs, the payor has a remedy.
Once a payor discovers a mispayment, it should first determine whether there is both an overpayment to one payee and a corresponding underpayment to another payee. If both are present, the payor should then determine whether the payees have signed division orders. If they did, the underpaid payee must recover from the overpaid payee under Gavenda v. Strata Energy, Inc., 705 S.W.2d 690, 691 (Tex. 1986). Typically, no further action by the payor is necessary.
If there is only an overpayment, recovering the overpaid money can be more challenging. The payee may have dissipated the money, or it may not be economically feasible to attempt recovery. Such practical challenges notwithstanding, commentators generally agree that a payor who mistakenly overpays royalties is legally entitled to recover the overpayment.
One commentator notes that “where as a result of good-faith mistake royalty has been paid to a person not entitled to receive same or where excessive payments have been made in good faith, it is generally held that the lessee (or purchaser) who has made such payments may recover from the payee the payments to which he is not entitled.” Williams & Meyers Oil and Gas Law § 657 (4th ed. 2010). Another commentator more broadly states that the right of the payor to withhold overpayment from royalty is an exercise of the right of recoupment. 3 Kuntz, Law of Oil and Gas § 42.8 (1989).
Oil and gas jurisprudence recognizes at least two ways in which a payor may exercise its right of recoupment. One option is to assert an affirmative recoupment claim, which typically sounds in equity as a claim for money had and received. This claim seeks to avoid unjust enrichment and generally requires proving two elements: (1) the defendant holds money; and (2) the money, in equity and good conscience, belongs to the plaintiff. In short, the payor may recover if the payee received a benefit that is unconscionable for it to retain.
In addition to seeking judicial relief, some jurisdictions have recognized the payor’s right to exercise “self-help” recoupment by withholding future royalties. The Kansas Supreme Court in Waechter v. Amoco Production Co. provided a detailed analysis of this issue. 537 P.2d 228 (Kan. 1975). There, the court concluded that a payor’s “extra-judicial” action of withholding future royalties was permissible because the payor came into possession of the royalties lawfully—that is, the payor had the right to receive proceeds from gas sales, and thus the monies were not acquired by force or unfair means.
The Waechter court also explained that the payor’s right to be refunded is a right of recoupment implied at law to avoid unjust enrichment. The payees argued that the payor’s recoupment was impermissible as barred by limitations (the payor self-help recouped five years after its cause of action accrued). The court disagreed, however, explaining that a statute of limitations is remedial in nature and does not confer a right of action. Thus, while the expiration of limitations might bar an affirmative remedy, it neither discharges a debt nor prevents a payor from asserting its right of recoupment defensively. Therefore, the payor in Waechter asserted its recoupment right to defeat the payees’ claims of nonpayment following its self-help remedy.
Texas courts have also recognized the claims, defenses and doctrines permeating the Waechter holding, including recoupment as a counterclaim, defensive recoupment, setoff, and how the “pure defense” doctrine allows an affirmative claim that is otherwise barred by limitations to be asserted defensively to defeat or reduce a plaintiff’s claim. Although every case is different, the payor generally has a right to recoup mistakenly overpaid royalties paid in good faith, and to do so it may seek affirmative relief from the courts or, in certain situations, exercise self-help by retaining future royalties to recoup the overpaid money.
Douglas R. Hafer is a partner and Daniel B. Mathis an associate at Curnutt & Hafer, L.L.P., where they practice oil and gas litigation. Both are members of the DBA Energy Law Section and may be reached at email@example.com and firstname.lastname@example.org, respectively.