Does the Texas Prompt Pay Act (PPA), requiring prompt payment of contractors involved in construction projects, apply to construction of a natural gas facility intended to extract propane, butane and other natural gas liquids (NGLs) in a midstream capture process? The Houston Court of Appeals, First District, in Arrow Field Services, LLC v. Linde Engineering North America, Inc, recently held, no.

Arrow Field Services, LLC (Arrow) is a midstream company located in North Dakota which acquires and processes natural gas to extract NGLs. Linde Engineering North America, Inc. (Linde) provides construction, engineering, procurement, and project management services to companies in the oil and gas industry. In April 2018, Arrow retained Linde as general contractor under written contract to construct the Bear Den II facility in North Dakota, a facility that would use cryogenic technology to freeze the gas stream for extraction of NGLs. Under the contract, certain costs were characterized as reimbursable.

Arrow imposed an aggressive construction schedule, requiring the Bear Den II plant be operational by August 2019, less than the customary 24-month construction cycle for these types of facilities. Compounding the tight schedule, during the course of construction, Arrow requested numerous changes to the facility, including increasing the size of plant from 60,000 to 120,000 square process area and moving the control building from the middle of the plant to the top of a hill. The construction cost ballooned from $65 million Base Cost with $9.5 million Fixed Fee to about $156 million.

While the costs increased, Arrow and its Houston-based parent company, Crawford Midstream Partners, LP (Crestwood), grew increasingly concerned. Arrow and Crestwood opted to exercise the audit rights under the contract to determine whether the costs—particularly from subcontractors to Linde—were substantiated, reasonable and necessary. Although Linde initially cooperated by providing additional records, at some point it stopped. Arrow sent a notice of default to Linde premised in part on Linde’s failure to cooperate in the audit process.  Based on Arrow’s retained consultant, Veritas, determination that about $24 million of costs were not allowed under the contract, Arrow withheld payment to Linde of about $31 million.

Linde initiated this lawsuit to obtain payment, interest and attorney’s fees. During the course of litigation, Arrow paid Linde about $22 million as partial payment for unpaid Base Costs contemplated in the contract. After a 5-week trial, the jury awarded Linde approximately $43 million in damages, fees and costs, including  interest under the PPA of $17.6 million and attorneys’ fees under the PPA of $4.6 million. Arrow appealed, arguing among other things that the PPA did not apply to the gas production facility at issue.

The Court began its analysis by reviewing the applicability of the PPA. Arrow argued that the PPA’s “mineral exemption” excluded the parties’ contract. In response, Linde argued that a construction contract for a manufacturing facility is not encompassed in the mineral exemption.

The mineral exemption provides that the PPA does not apply to any agreement: (1) to explore, produce, or develop oil, natural gas, natural gas liquids, synthetic gas, sulfur, ore, or other mineral substances, including any lease or royalty agreement, joint interest agreement, production or production-related agreement, operating agreement, farmout agreement, area of mutual interest agreement, or other related agreement; (2)  for any well or mine services; or (3)  to purchase, sell, gather, store, or transport oil, natural gas, natural gas liquids, synthetic gas, or other hydrocarbon substances by pipeline or by a fixed, associated facility.

The Court held that the mineral exemption applied. It was undisputed that Linde’s contract encompassed construction, bringing the contract within the PPA. In finding the exemption applied, the Court held that the Bear Den II facility “produced” NGLs in that NGLs are “brought into existence” through the cryogenic process. It also held that the facility was intended to “develop” NGLS in that the facility was step in capturing and producing hydrocarbons. Finally, the Court held that the Bear Den II facility “gathered” natural gas from various pipelines, “stored” the gas and NGLs, and “transported” the gas through pipelines, bringing the entire project within the mineral exemption.

As the PPA was inapplicable to the dispute, the Court reversed the jury award of $4.6 million awarded in attorney’s fees and $130,568.00 in costs, both awarded based on the PPA. The Court further ordered that prejudgment interest be recalculated from the 18% under the PPA to the lower amount for non-PPA verdicts.

The attorneys in our Austin and Dallas offices have significant experience representing parties in payment disputes, including disputes governed by PPA. Please contact us at info@gstexlaw.com with any questions you may have.

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