How Do I Find Out If My Royalty Is Correct?
By Paul R. Yagelsi, Esq.
Four Ways to Verify If Your Oil and Gas Royalty Is Correct
You have received your royalty check, but something is wrong. Your royalty does not appear to be correct. It is too low. It could be that the deductions are too high. It could be that although your lease allows for certain deductions, deductions are being taken that are prohibited by your lease. It could be that deductions are being taken, but your lease specifically prohibits deductions. Whatever the scenario, how can you, the royalty owner, check the expenses and deductions that are being taken by the oil and gas company? How can you check the books and records of the oil and gas company to ascertain whether your royalty is correct? There are four basic ways this can be done: (1) you can make a request of the oil and gas company for the information you need, (2) you can make a request for the information you need pursuant to a statute, (3) you can make a request for an audit pursuant to an audit clause in your oil and gas lease, or (4) you can file a lawsuit.
(1) You make a request to review your oil and gas company’s books and records.
If you have a problem with your royalty, you can contact your oil and gas company to inquire about the amount of your royalty; however, this may be fraught with difficulties. First, you may have difficulty in locating the appropriate department or person who can answer your questions. If you are able to get in contact with the appropriate person, you may not get the information. If you do get information, it may be a while before you get it or you may not get the information you want or need; the records may not be sufficient. If you are not satisfied, unless there is a statute or an audit clause in your lease which requires the oil and gas company to open its books and records, you may not be able to get the information you want or need without filing a lawsuit.
(2) You make a request for information pursuant to a state statute.
Currently, Pennsylvania has no state statute which requires that an oil and gas company open its books and records to a lessor in order for the lessor to check if the royalty payment is correct. If such a statute is enacted or is already enacted in the jurisdiction in which you are living, you need to check the statute to ascertain what information you can obtain, when it can be obtained, how it can be obtained, and where it can be obtained. The provisions of the statute must be complied with in order to obtain the information that is required to be provided under the statute.
(3) You make a request pursuant to an audit clause in your oil and gas lease.
What is an audit clause? An audit clause is a provision in an oil and gas lease which imposes a contractual obligation upon the oil and gas company to provide you with information/documents so that you can check the accuracy of the royalties you have received. If you need to verify your royalty, an audit clause is probably the best way to do so. You will rarely see an audit clause in an oil and gas lease provided by the oil and gas company. Accordingly, an audit clause is a provision that you should request when negotiating your oil and gas lease.
What should be in an audit clause?
The basic provisions of an audit clause include the right to request, at least once a year, access to the oil and gas company’s books and records in order to conduct an inspection, examination, or audit to verify that the royalties you are receiving are what you should be receiving under your oil and gas lease. The language of the clause should provide that either you or your designated agent can inspect, examine, or audit the oil and gas company’s books and records, which should be done at an office that is convenient for you.
The language of the audit clause should be broad as to what you can do. It should include more than just “audit” as an audit, in the accounting sense, may be more than you need or want. Accordingly, the language of this clause should give you the right to either inspect, examine, or audit the oil and gas company’s books and records.
What happens if you do perform an inspection, examination, or audit and there appears to be a deficiency? If it is found that monies are owed to you, there should be a provision in your audit clause that requires the oil and gas company to pay you the missing monies, possibly with interest.
The following is an example of an audit clause:
Lessee further grants to Lessor or Lessor’s agent or representative the right annually to examine, inspect or audit, books, records, and accounts of Lessee pertinent to the purpose of verifying the accuracy of the reports and statements furnished to Lessor, and for checking the amount of payments lawfully due the Lessor under the terms of the Lease. Not later than ten (10) days from the date of Lessor’s written request to Lessee of Lessor’s intended examination, inspection or audit, which shall be conducted during normal business hours at the local office of the Lessee, Lessee shall afford Lessor the time necessary in Lessor’s determination to conduct a full examination, inspection or audit covering the purposes described above. Said examination, inspection or audit will be at Lessor’s sole cost and expense unless the examination, inspection or audit reveals deficiencies or underpayments. If so, then within thirty (30) days of Lessor’s written notice to Lessee of any deficiencies or underpayments, Lessee shall pay to Lessor the cost of the audit and reimburse any deficiencies or underpayments plus interest at the rate of one and one-half percent (1.5%) per month.
Whether there will be an audit clause in your oil and gas lease is subject to negotiation. When you receive an oil and gas lease from an oil and gas company, check the provisions, including any addendum, to see whether an audit clause is present. If it is not, your attorney should negotiate the inclusion of such a clause into your oil and gas lease. If you can negotiate an audit clause, the language at a minimum should include the right to annually inspect, examine or audit the books and records of the company in order to verify or check the accuracy of your royalty payments.
You should always try to negotiate an audit clause. If you do not, and if there is no statute in your state, which provides the royalty owner with the right to check the books and records of the oil and gas company to verify what is being paid, then you are either left to the mercy of the oil and gas company to provide you with the information that you request and need or you are left with the option of filing a lawsuit, which, for the following reasons, is probably not an option at all.
(4) Filing a lawsuit to obtain the information that you need.
If upon your request, no information is provided or if you are not satisfied with the information that is provided to verify if your royalty is correct, and there is no state statute requiring the oil and gas company to open its books and records to you and if there is no audit clause in your lease, a lawsuit should be considered. This option, however, is probably the most costly and time consuming option that is available. You do not want to have to go to court to force the turnover of information that you need to determine whether your royalty is correct. Legal action may be so costly and so time consuming that in the end, it is not a viable option.
When you receive a lease offer, contact an oil and gas attorney. There are a number of things that should be reviewed before you sign an oil and gas lease. One is whether the proffered oil and gas lease contains an audit clause. If it does not, one should be negotiated. We can help negotiate the oil and gas lease, including the inclusion of an audit clause.