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A 'STATE-FRIENDLY' OIL LEASE PAYS OFF FOR ALABAMA

Feb 19, 2001

NATIONAL LAW JOURNAL

Case Type: breach of lease, fraud

Case: Exxon Corp. v. Department of Conservation and Nat. Res., CV-99-2368 (Montgomery Co., Ala., Cir. Ct)

Plaintiff's Attorney: Joe Espy of Montgomery, Ala.'s Melton Espy, Williams & Hayes

Defense Attorneys: John T. Crowder, Robert T. Cunningham Jr. and Richard T. Dorman of Mobile's Cunningham, Bounds, Yance, Crowder & Brown

Jury Award: $3.5 billion to the defendant on its counterclaim

In 1981 and 1984, the state of Alabama leased the mineral rights to natural gas to Exxon Corp. part of the Mobile Bay field in the Gulf of Mexico.

The state drew up "a state-friendly oil and gas lease," said counsel Robert T. Cunningham, which required Exxon to pay royalties on a gross proceeds basis. The common oil and gas lease sets royalties on a well-head value," 'when the gas is worth less," he said.

The lease also prohibited the free use of fuel, he said. With the typical lease, "the oil company can use the gas out of the ground to run its facility and not pay royalties," Mr. Cunningham said. Under the terms of this lease, Exxon had to pay royalties on gas used to run the operation. Exxon signed this lease 22 times on separate tracts in the same general area in Mobile Bay, Mr. Cunningham said.

In 1993, after years of developing the gas field, Exxon began taking out, processing and selling the natural gas from the Mobile Bay wells, he said.

At that point, he said, "Exxon made a corporate decision that it would treat this as if the lease was a well-head lease. Exxon would take deductions for costs and pay on well-head value, and they would take free use of the fuel."

"Exxon made an economic analysis, calculating what the risks of litigation were," versus the costs of paying according to the lease. Mr. Cunningham charged. A letter by an Exxon attorney unearthed during the discovery process, he added, indicated that even if Alabama realized the state was being paid less than the lease agreement warranted and sued, the cost to the company would be minimal; Exxon would only have to pay the extra royalty, plus interest and attorney fees. The letter described the Alabama Department of Conservation and Natural Resources staff as "inexperienced." Mr. Cunningham said. "The implication was that Bubba ain't going to find out what's happening." The state also charged that Exxon had "filed false reports" on the amount of gas being taken out from the wells and that the company deducted expenses that were unrelated to the Mobile Bay operation.

Exxon filed a declaratory judgment action against the state; the state counterclaimed, charging fraud and breach of the lease agreement.

Exxon contended, spokesman Thomas Cirigliano said, that the lease was "ambiguous" and that the company and the state had a simple "legitimate dispute over the interpretation of how to calculate royalties. We paid the royalties by our interpretation and by standard industry practice."

The company filed a declaratory judgment action to get a court to determine how royalties should be paid, he said. "The state took an extra step and sued Exxon over a legitimate dispute." Exxon, now ExxonMobil, paid the state $1 billion in royalties and bonus payments on the leases, he said; the difference between the amount Exxon paid and what the state claimed the company should have paid was about $40 million. Exxon also said it never attempted to conceal its actions. "The state knew exactly how ExxonMobil was going to pay royalties on this ambiguous lease form before the first royalty payment was made," he said. "No one was hiding the facts."

The claim by the state that Exxon determined it could get away with cheating the people of Alabama because they were too naive to catch on was "absolutely untrue," he said. The statement calling the people of Alabama "too inexperienced" referred only to the staff members of the Alabama Department of Conservation and Natural Resources, which drafted the lease, he said. "In context, the statement is an attempt to explain why the Alabama lease form is so unclear."

On Dec. 19, a Montgomery, Ala., jury ordered Exxon to pay the state $87.7 million in compensatory damages and $3.42 billion in punitives. Mr. Cirigliano called the verdict "manifestly unfair." Exxon has filed motions to set aside the verdict.

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