UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NO. 1-8032
SAN JUAN BASIN ROYALTY TRUST
(Exact name of registrant as specified in the Amended and Restated San Juan
Basin Royalty Trust Indenture)
TEXAS 75-6279898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
TEXASBANK, TRUST DEPARTMENT
2525 RIDGMAR BOULEVARD,
SUITE 100
FORT WORTH, TEXAS 76116
(Address of principal executive offices) (Zip Code)
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TELEPHONE NUMBER: (866) 809-4553
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Number of Units of beneficial interest outstanding at May 14, 2003: 46,608,796
SAN JUAN BASIN ROYALTY TRUST
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The condensed financial statements included herein have been prepared by the independent accountants for the San Juan Basin Royalty Trust (the "Trust"), at the request of TexasBank, the Trustee of the Trust, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 47, released September 16, 1982, the Trust continues to prepare its financial statements in a manner that differs from accounting principals generally accepted in the United States of America ("GAAP"); such presentation is customary to other royalty trusts. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted pursuant to Rule 10-01 of Regulation S-X promulgated under the Securities and Exchange Act of 1934, although the Trustee believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in the Trust's annual report on Form 10-K/A for the year ended December 31, 2002. In the opinion of the Trustee, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the assets, liabilities and trust corpus of the San Juan Basin Royalty Trust at March 31, 2003, and the distributable income and changes in trust corpus for the three-month periods ended March 31, 2003 and 2002 have been included. The distributable income for such interim periods is not necessarily indicative of the distributable income for the full year.
SAN JUAN BASIN ROYALTY TRUST
CONDENSED STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
MARCH 31, DECEMBER 31,
2003 2002
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(UNAUDITED)
ASSETS
Cash and short-term investments............................. $ 9,401,502 $ 4,274,790
Net overriding royalty interest in producing oil and gas
properties (net of accumulated amortization of
$100,623,167 and $99,577,622 at March 31, 2003 and
December 31, 2002, respectively).......................... 32,652,361 33,697,906
----------- -----------
$42,053,863 $37,972,696
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LIABILITIES AND TRUST CORPUS
Distribution payable to Unit Holders........................ $ 9,286,644 $ 4,159,932
Cash reserves............................................... 114,858 114,858
Trust corpus -- 46,608,796 Units of beneficial interest
authorized and outstanding................................ 32,652,361 33,697,906
----------- -----------
$42,053,863 $37,972,696
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CONDENSED STATEMENTS OF DISTRIBUTABLE INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
2003 2002
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Royalty income.............................................. $19,911,068 $3,925,355
Interest income............................................. 7,453 746
Decrease in cash reserves................................... -- 76,761
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19,918,521 4,002,862
General and administrative expenditures..................... 420,374 475,850
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Distributable income........................................ $19,498,147 $3,527,012
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Distributable income per Unit (46,608,796 Units)............ $ 0.418337 $ 0.075673
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The accompanying notes to condensed financial statements are an integral part of these statements.
SAN JUAN BASIN ROYALTY TRUST
CONDENSED STATEMENTS OF CHANGES IN TRUST CORPUS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
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Trust corpus, beginning of period........................... $ 33,697,906 $37,859,749
Amortization of net overriding royalty interest............. (1,045,545) (380,704)
Distributable income........................................ 19,498,147 3,527,012
Distributions declared...................................... (19,498,147) (3,527,012)
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Total corpus, end of period................................. $ 32,652,361 $37,479,045
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The accompanying notes to condensed financial statements are an integral part of these statements.
SAN JUAN BASIN ROYALTY TRUST
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF ACCOUNTING
The San Juan Basin Royalty Trust was established as of November 1, 1980. The financial statements of the Trust are prepared on the following basis:
- Royalty income recorded for a month is the amount computed and paid by the working interest owner, Burlington Resources Oil & Gas Company LP ("BROG"), to the Trustee for the Trust. Royalty income consists of the amounts received by the owner of the interest burdened by the net overriding royalty interest ("Royalty") from the sale of production less accrued production costs, development and drilling costs, applicable taxes, operating charges, and other costs and deductions, multiplied by 75%.
- Trust expenses recorded are based on liabilities paid and cash reserves established from Royalty income for liabilities and contingencies.
- Distributions to Unit Holders are recorded when declared by the Trustee.
- The conveyance which transferred the overriding royalty interest to the Trust provides that any excess of production costs over gross proceeds must be recovered from future net profits.
The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in the month of production; certain cash reserves may be established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; and amortization of the Royalty calculated on a unit-of-production basis is charged directly to trust corpus instead of as an expense. The basis of accounting used by the Trust is widely used by royalty trusts for financial reporting purposes.
2. FEDERAL INCOME TAXES
For federal income tax purposes, the Trust constitutes a fixed investment trust which is taxed as a grantor trust. A grantor trust is not subject to tax at the trust level. The Unit Holders are considered to own the Trust's income and principal as though no trust were in existence. The income of the Trust is deemed to have been received or accrued by each Unit Holder at the time such income is received or accrued by the Trust rather than when distributed by the Trust.
The Royalty constitutes an "economic interest" in oil and gas properties for federal income tax purposes. Unit Holders must report their share of the revenues of the Trust as ordinary income from oil and gas royalties and are entitled to claim depletion with respect to such income. The Royalty is treated as a single property for depletion purposes.
The Trust has on file technical advice memoranda confirming the tax treatment described above.
The Trust began receiving royalty income from coal seam gas wells beginning in 1989. Under Section 29 of the Internal Revenue Code, coal seam gas production from wells drilled prior to January 1, 1993 (including certain wells recompleted in coal seam formations thereafter) generally qualifies for the federal income tax credit for producing non-conventional fuels if such production and the sale thereof occurs before January 1, 2003. For 2002, this tax credit was approximately $1.09 per MMBtu. The Trust also receives production from wells producing from a tight sands formation, which likewise generally qualifies for the federal income tax credit for producing non-conventional fuels if such production and the sale thereof occurs before January 1, 2003. However, these wells must have been drilled after November 5, 1990, or must have been committed or dedicated to interstate commerce (as defined in Section 2(18) of the Natural Gas Policy Act as in effect November 5, 1990) as of April 20, 1977. Unlike the credit for coal seam gas, the credit for tight formation gas is not adjusted for inflation, so the credit remains fixed at .517241 per MMBtu. For qualifying production of the Trust, each Unit Holder must determine, from the tax information the Unit Holder receives from the
SAN JUAN BASIN ROYALTY TRUST
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Trust, its pro rata share of such production based upon the number of Units
owned during each month of the year and the amount of available credit per MMBtu
for the year, and then apply the tax credit against the Unit Holder's own income
tax liability, but such credit may not reduce the Unit Holder's regular tax
liability (after the foreign tax credit and certain other nonrefundable credits)
below its tentative minimum tax. Section 29 also provides that any amount of
Section 29 credit disallowed for the tax year solely because of this limitation
will increase their credit for prior year minimum tax liability, which may be
carried forward indefinitely as a credit against the taxpayer's regular tax
liability, subject, however, to the limitations described in the preceding
sentence. There is no provision for the carryback or carryforward of the Section
29 credit in any other circumstances.
Congress is considering extending the Section 29 credit beyond its December 31, 2002 expiration date, and the creation of a similar tax credit for new production. Unless new legislation is passed, extending the Section 29 on existing eligible production or allowing for a credit on eligible new production, there will be no further Section 29 credit on the Trust's production sold in the year 2003 or later years.
The Trustee is provided summary Section 29 tax credit information related to Trust properties by BROG, which information is then passed along to the Unit Holders. In 1999, the U.S. Court of Appeals for the 10th Circuit upheld the position of the Internal Revenue Service and the Tax Court that nonconventional fuel such as coal seam gas does not qualify for the Section 29 credit unless the producer has received an appropriate well category determination from the Federal Energy Regulatory Commission ("FERC"). The FERC's certification authority expired effective January 1, 1993. However, on July 14, 2000, the FERC issued a final ruling amending its regulations to reinstate certain regulations involving well category determinations for all wells and tight formation areas that could qualify for the Section 29 tax credit. BROG has informed the Trustee that it will seek certification of all qualified wells and that two additional wells were certified in 2002.
The classification of the Trust's income for purposes of the passive loss rules may be important to a Unit Holder. As a result of the Tax Reform Act of 1986, royalty income will generally be treated as portfolio income and will not reduce passive losses.
3. CONTINGENCIES
See Part II -- Item 1, "Legal Proceedings" concerning the status of litigation matters.
4. SETTLEMENT OF CLAIMS RELATING TO GAS IMBALANCE
In June 2000, the Trust and BROG entered into a partial settlement of claims relating to a gas imbalance with respect to production from mineral properties currently operated by BROG. Under the terms of the partial settlement BROG paid the Trust $3,490,000 to settle the imbalance insofar as it relates to some of the wells located on the subject properties. The remainder of the imbalance is to be addressed through volume adjustments whereby the Trust's net overriding royalty interest will be applied to 50% of the overproduced parties' interest, on a monthly basis, until the imbalance is corrected. The Trust is in communication with BROG in order to determine the estimated value of the volume adjustments and the time during which the remainder of the imbalance will be corrected. Such volume adjustments will be monitored by the Trust's consultants.
5. COMMITMENTS AND CONTINGENCIES
At December 31, 2001, BROG had incurred excess production costs of $2,259,628 on the underlying properties due primarily to high capital costs. The Trust conveyance provides for the deduction of excess production costs in determining royalty income until such costs are fully recovered and allows for interest to be charged on excess production costs at the prime rate. Interest in the amount of $10,545 was added to such
SAN JUAN BASIN ROYALTY TRUST
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
excess production costs. Of the total, $1,702,630 is attributable to the Trust and was deducted in determining first quarter 2002 royalty income.
6. SUBSEQUENT EVENTS
As part of a settlement between BROG and the Mineral Management Service of the United States Department of the Interior, $901,776 was deducted from the April 2003 royalty payment. This represents the Trust's 75% interest of the total settlement.
ITEM 2. TRUSTEE'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
Certain information included in this report contains, and other materials filed or to be filed by the Trust with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Trust) may contain or include, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Such forward-looking statements may be or may concern, among other things, capital expenditures, drilling activity, development activities, production efforts and volumes, hydrocarbon prices and the results thereof, and regulatory matters. Such forward-looking statements generally are accompanied by words such as "may," "will," "estimate," "expect," "predict," "anticipate," "goal," "should," "assume," "believe," "plan," "intend," or other words that convey the uncertainty of future events or outcomes. Such statements reflect BROG's current view with respect to future events; are based on our assessment of, and are subject to, a variety of factors deemed relevant by the Trustee and BROG and involve risks and uncertainties. Should one or more of these risks or uncertainties occur, actual results may vary materially and adversely from those anticipated.
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
The Trust received royalty income of $19,911,068 and interest income of $7,453 during the first quarter of 2003. There was no change in cash reserves. After deducting administrative expenses of $420,374, distributable income for the quarter was $19,498,147 ($.418337 per Unit). In the first quarter of 2002, royalty income was $3,925,355, interest income was $746, cash reserves decreased $76,761, administrative expenses were $475,850 and distributable income was $3,527,012 ($.075673 per Unit). The tax credit relating to production from coal seam and tight sand wells sold before January 1, 2003, totaled approximately .03 per Unit for the first quarter of 2003 and $.01 per Unit for the first quarter of 2002. For further information concerning this tax credit, Unit Holders should refer to the Trust's Annual Report for 2002. Based on 46,608,796 Units outstanding, the per Unit distributions during the first quarter of 2003 were as follows:
January..................................................... $.100682
February.................................................... .118408
March....................................................... .199247
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Quarter Total............................................... $.418337
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The royalty income distributed in the first quarter of 2003 was higher than that distributed in the first quarter of 2002, primarily due to an increase in the average gas price from $2.20 per Mcf for the first quarter of 2002 to $3.51 per Mcf for the first quarter of 2003 and decreased capital expenditures. Interest earnings for the quarter ended March 31, 2003, as compared to the quarter ended March 31, 2002, were higher, primarily due to an increase in funds available for investment. Administrative expenses were lower primarily as a result of differences in timing in the receipt and payment of these expenses but also because administrative expenses in the first quarter of 2002 included expenses incurred in an arbitration proceeding involving BROG and the Trust undertaken to resolve certain gas marketing issues.
The capital costs attributable to the properties from which the Trust's 75% net overriding royalty ("Royalty") was carved (the "Underlying Properties") for the first quarter of 2003 were reported by BROG as approximately $6.6 million. BROG's capital expenditure budget for the Underlying Properties for 2003 is estimated at $14.2 million, however, BROG reports that based on its actual capital requirements, its mix of projects, and swings in the price of natural gas, the actual capital expenditures for 2003 could range from $10 million to $22 million. Capital expenditures were approximately $11.3 million for the first quarter of 2002. In 2002, approximately $21.5 million in capital expenditures were deducted in calculating the Royalty. In February 2003, BROG informed the Trust that for 2003 it anticipates 351 projects, including the drilling of 38 new wells to be operated by BROG and 26 new wells to be operated by third parties. Of the new BROG operated wells, 14 are projected to be conventional wells completed in the Pictured Cliffs, Mesaverde and/or
Dakota formations, and the remaining 24 are projected as coal seam wells completed in the Fruitland Coal formation. A total of 21 of the new wells operated by third parties are projected to be conventional wells and the remaining five are to be coal seam wells. BROG projects approximately $10.6 million to be spent on the new wells, and $3.6 million to be expended in working over existing wells and in the maintenance and improvement of production facilities.
BROG indicates its budget for 2003 reflects continued, significant developments in which the Trust's net overriding royalty interest is relatively high, as well as a sustained focus in conventional formations, including infill drilling to the Mesaverde and Dakota formations, development of the Fruitland Coal formation and multiple formation completions.
BROG previously informed the Trust that increases in its capital program, particularly in 2000 through 2002, were designed to offset the natural decline in production from the Underlying Properties. BROG has reported favorable results in this effort in that natural gas production for calendar 2002 averaged approximately 127 MMcf per day, as compared to average production of approximately 121 MMcf per day for calendar 2001 and 116 MMcf per day for calendar 2000. BROG has reported that natural gas production for the first quarter of 2003 averaged approximately 126 MMcf per day.
In October 2002, the New Mexico Oil Conservation Division approved reduced, 160-acre spacing in selected portions of the Fruitland Coal formation. BROG has informed the Trust that, principally as a result of this approval, its budget for 2003 reflects a focus on the Fruitland Coal formation. In February 2002, BROG informed the Trust that the New Mexico Oil Conservation Division had approved plans for 80-acre infill drilling of the Dakota formation in the San Juan Basin. The New Mexico Oil Conservation has asked BROG and other interested parties to study over the next year whether the change in spacing requirements should be expanded to cover other portions of that reservoir. Eighty-acre spacing has been permitted in the Mesaverde formation since 1997.
BROG has informed the Trust that lease operating expenses and property taxes were $3,921,567 and $136,250 respectively, for the first quarter of 2003, as compared to $4,136,247 and $75,567, respectively, for the first quarter of 2002.
The war in Iraq has increased the volatility in prices for oil and gas. It is unclear what effect the war in Iraq will have on the net proceeds received by the Trust and, accordingly, distributable income.
BROG has informed the Trustee that during the first quarter of 2003, two gross (0.88 net) coal seam miscellaneous projects, seven gross (0.87 net) coal seam wells, three gross (0.94 net) miscellaneous capital projects, nine gross (6.56 net) conventional wells, 19 gross (0.92 net) payadds, and five gross (3.21 net) restimulations were completed on the Underlying Properties.
Twenty-seven gross (9.53 net) coal seam wells, one gross (0.002 net) recavitation, four gross (0.14 net) recompletions, 25 gross (13.02 net) conventional wells, 27 gross (2.52 net) payadds, 14 gross (4.55 net) recompletions and 26 gross (17.56 net) restimulations were in progress at March 31, 2003.
There were 43 gross (15.01 net) conventional wells, 18 gross (8.26 net) conventional recompletions, two gross (1.74 net) miscellaneous capital projects, nine gross (1.81 net) coal seam wells, three gross (0.90 net) miscellaneous coal seam capital projects, one gross (0.02 net) coal seam recavitation, and four gross (0.14 net) coal seam recompletions completed as of March 31, 2002.
Sixty-four gross (13.23 net) conventional wells, 25 gross (7.32 net) conventional recompletions, five gross (0.51 net) miscellaneous capital projects, 10 gross (0.50 net) restimulations and five gross (2.73 net) payadds were in progress as of March 31, 2002. Seven gross (4.07 net) coal seam wells, nine gross (5.18 net) coal seam recompletions, one gross (0.04 net) miscellaneous coal seam capital project, and one gross (0.007 net) coal seam restimulation were in progress as of March 31, 2002.
"Gross" acres or wells, for purposes of this discussion, means the entire ownership interest of all parties in such properties, and BROG's interest therein is referred to as the "net" acres or wells. A payadd is the completion of an additional production interval in an existing completed zone in a well.
During the first quarter of 2002, 43 gross (15.01 net) conventional wells, 18 gross (8.26 net) conventional recompletions, two gross (1.74 net) miscellaneous capital projects, nine gross (1.81 net) coal seam wells, three gross (0.90 net) miscellaneous coal seam capital projects, one gross (0.02 net) coal seam recavitation, and four gross (0.14 net) coal seam recompletions were completed as of March 31, 2002. Sixty-four gross (13.23 net) conventional wells, 25 gross (7.32 net) conventional recompletions, five gross (0.51 net) miscellaneous capital projects, 10 gross (0.50 net) restimulations and five gross (2.73 net) payadds were in progress as of March 31, 2002. Seven gross (4.07 net) coal seam wells, nine gross (5.18 net) coal seam recompletions, one gross (0.04 net) miscellaneous coal seam capital project, and one gross (0.007 net) coal seam restimulation were in progress as of March 31, 2002.
Royalty income for the quarter ended March 31, 2003 is associated with actual gas and oil production during November 2002 through January 2003 from the Underlying Properties. Gas and oil sales from the Underlying Properties for the quarters ended March 31, 2003 and 2002 were as follows:
2003 2002
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Gas:
Total sales (Mcf)........................................ 11,637,548 11,470,975
Mcf per day.............................................. 126,495 124,685
Average price (per Mcf).................................. $ 3.51 $ 2.20
Oil:
Total sales (Bbls)....................................... 16,107 23,454
Bbls per day............................................. 175 255
Average price (per Bbl).................................. $ 24.44 $ 15.78
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Gas and oil sales attributable to the Royalty for the quarters ended March 31, 2003 and 2002 were as follows:
Gas sales (Mcf)............................................. 6,151,128 1,925,143 Oil sales (Bbls)............................................ 8,339 4,324 |
Sales volumes attributable to the Royalty are determined by dividing the net profits received by the Trust and attributable to oil and gas, respectively, by the prices received for sales volumes from the Underlying Properties, taking into consideration production taxes attributable to the Underlying Properties. Since the oil and gas sales attributable to the Royalty are based on an allocation formula that is dependent on such factors as price and cost, including capital expenditures, the aggregate production volumes from the Underlying Properties may not provide a meaningful comparison to volumes attributable to the Royalty.
During the first quarter of 2003, average gas prices were $1.31 higher than the average prices reported during the first quarter of 2002. The average price per barrel of oil during the first quarter of 2003 was $8.66 per barrel higher than that received for the first quarter of 2002 due to increases in oil prices in world markets generally, including the posted prices applicable to oil sales attributable to the Royalty.
BROG has entered into two contracts for the sale of all volumes of gas subject to the Royalty (the "Trust gas"). These contracts provide for (i) the sale of Trust gas in two packages to Duke Energy and Marketing, L.L.C. and PNM Gas Services, respectively, (ii) the delivery of Trust gas at various delivery points over a two year period ending March 31, 2004, and from year-to-year thereafter until terminated by either party on twelve months notice, and (iii) for the sale of Trust gas at prices which fluctuate in accordance with published indices for gas sold in the San Juan Basin of New Mexico. Neither party to either of the two contracts elected to give the twelve months notice required to terminate the contracts effective March 31, 2004, and accordingly, the term of both contracts has been extended through March 31, 2005. Unit Holders are referred to Note 6 of the Notes to Financial Statements in the Trust's 2002 Annual Report for further information concerning the marketing of gas produced from the Underlying Properties. Prior to April 1, 2002, the Trust gas was sold under a contract dated November 10, 1999 between BROG and Duke Energy and Marketing L.L.C.
Confidentiality agreements with purchasers of gas produced from the Underlying Properties prohibit public disclosure of certain terms and conditions of gas sales contracts with those entities, including specific pricing terms, gas receipt points, etc. Such disclosure could compromise the ability to compete effectively in the marketplace for the sale of gas produced from the Underlying Properties.
CALCULATION OF ROYALTY INCOME
Royalty income received by the Trust for the three months ended March 31, 2003 and 2002, respectively, was computed as shown in the following table:
2003 2002
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Gross proceeds of sales from the Underlying Properties:
Gas proceeds............................................... $40,863,040 $25,216,887
Oil proceeds............................................... 393,663 370,150
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Total...................................................... 41,256,703 25,587,037
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Less production costs:
Severance tax -- Gas....................................... 4,037,766 2,499,137
Severance tax -- Oil....................................... 34,209 35,954
Lease operating expense and property tax................... 4,057,817 4,211,814
Other...................................................... 15,000 10,000
Capital expenditures....................................... 6,563,820 11,326,153
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Total...................................................... 14,708,612 18,083,058
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Less excess production and interest from prior year........ -- 2,270,173
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Net profits................................................ 26,548,091 5,233,806
Net overriding royalty interest............................ 75% 75%
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Royalty income............................................. $19,911,068 $ 3,925,355
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CONTRACTUAL OBLIGATIONS
Under the Trust's indenture, the Trustee is entitled to an administrative fee for its administrative services and the preparation of quarterly and annual statements of: (i) 1/20 of 1% of the first $100 million of the annual gross revenue of the Trust, and 1/30 of 1% of the annual gross revenue of the Trust in excess of $100 million and (ii) the Trustee's standard hourly rates for time in excess of 300 hours annually. Beginning January 1, 2003, in no case will the administrative fee due under items (i) and (ii) above be less than $36,000 per year (as adjusted annually to reflect the increase (if any) in the Producers Price Index as published by the U.S. Department of Labor, Bureau of Labor Statistics).
EFFECTS OF SECURITIES REGULATION
As a publicly-traded trust listed on the New York Stock Exchange (the "NYSE"), the Trust is and will continue to be subject to extensive regulation under, among others, the Securities Act of 1933, the Securities Exchange Act of 1934, the rules and regulations of the NYSE and the Sarbanes-Oxley Act of 2002. Issuers failing to comply with such authorities risk serious consequences, including criminal as well as civil and administrative penalties. In most instances, these laws, rules and regulations do not specifically address their applicability to publicly-traded trusts, such as the Trust. In particular, the Sarbanes-Oxley Act of 2002 provides for the adoption by the Securities and Exchange Commission (the "SEC") of certain rules and regulations that may be impossible for the Trust to literally satisfy because of its nature as a pass-through trust. For example, the SEC is required to adopt rules and regulations pursuant to the Sarbanes-Oxley Act of 2002 that would require a publicly-traded company's board of directors, audit committee or executive directors (or similar body) to act with respect to certain corporate governance matters. The Trust does not
have, nor does the Indenture governing the Trust provide for, a board of directors, an audit committee or any executive officers. Accordingly, the Trust could not literally comply with such rules and regulations. It is the Trustee's intention to follow the SEC's rulemaking closely, attempt to comply with such rules and regulations and, where appropriate, request relief from these rules and regulations. However, if the Trust is unable to comply with such rules and regulations or to obtain appropriate relief, the Trust may be required to expend as yet unknown but potentially material costs to amend the Indenture that governs the Trust to allow for compliance with such rules and regulations.
CRITICAL ACCOUNTING POLICIES
In accordance with the Commission's staff accounting bulletins and consistent with other royalty trusts, the financial statements of the Trust are prepared on the following basis:
- Royalty income recorded for a month is the amount computed and paid by BROG to the Trustee for the Trust.
- Trust expenses recorded are based on liabilities paid and cash reserves established from royalty income for liabilities and contingencies.
- Distributions to Unit Holders are recorded when declared by the Trustee.
- The conveyance which transferred the Royalty to the Trust provides that any excess of production costs over gross proceeds must be recovered from future net profits.
The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in the month of production; certain cash reserves may be established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; and amortization of the Royalty calculated on a unit-of-production basis is charged directly to trust corpus instead of as an expense.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Trust invests in no derivative financial instruments, and has no foreign operations or long-term debt instruments. The Trust is a passive entity and other than the Trust's ability to periodically borrow money as necessary to pay expenses, liabilities and obligations of the Trust that cannot be paid out of cash held by the Trust, the Trust is prohibited from engaging in borrowing transactions. The amount of any such borrowings is unlikely to be material to the Trust. The Trust periodically holds short term investments acquired with funds held by the Trust pending distribution to Unit Holders and funds held in reserve for the payment of Trust expenses and liabilities. Because of the short-term nature of these borrowings and investments and certain limitations upon the types of such investments which may be held by the Trust, the Trustee believes that the Trust is not subject to any material interest rate risk. The Trust does not engage in transactions in foreign currencies which could expose the Trust or Unit Holders to any foreign currency related market risk. The Trust does not market the Trust gas, oil and/or natural gas liquids. BROG is responsible for such marketing.
ITEM 4. CONTROLS AND PROCEDURES
The Trust maintains a system of disclosure controls and procedures that is designed to provide reasonable assurance that information required to be disclosed in the Trust's filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Trust is accumulated and communicated by BROG to the Trustee and its employees who participate in the preparation of the Trust's periodic reports as appropriate to allow timely decisions regarding required disclosure. Due to the pass-through nature of the Trust, BROG provides much of the information disclosed in this Form 10-Q and the other periodic reports filed by the Trust with the SEC.
The Trustee receives periodic updates from BROG regarding activities related to the Trust. Accordingly, the Trust's ability to timely report certain information required to be disclosed in the Trust's periodic reports is dependent on BROG's timely delivery of such information to the Trust. In order to help ensure the accuracy and completeness of the information required to be disclosed in the Trust's periodic reports, the Trust employs independent public accountants, joint interest auditors, marketing consultants, attorneys and petroleum engineers. These outside professionals assist the Trustee in reviewing and compiling this information for inclusion in this Form 10-Q and the other periodic reports provided by the Trust to the SEC.
The Trustee has evaluated the Trust's disclosure controls and procedures within the 90 days prior to the filing of this Quarterly Report on Form 10-Q and has determined that, subject to BROG's delivery of timely and accurate information to the Trust, such disclosure controls and procedures are effective. The Trustee has not reviewed the Trust's disclosure controls and procedures in concert with management, a board of directors or an independent audit committee. The Trust does not have, nor does the Trust Indenture provide for, officers, a board of directors or an independent audit committee.
Subsequent to the Trustee's evaluation, there were no significant changes in internal controls or other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SETTLEMENTS
An administrative claim was initiated on March 17, 1997, by the Mineral Management Service of the United States Department of the Interior (the "MMS") against BROG regarding a gas contract settlement dated March 1, 1990, between BROG and certain other parties thereto. The claim alleged that additional royalties were due on production from federal and Indian leases in the State of New Mexico on properties burdened by the Trust. On December 3, 2001, BROG settled this claim by paying the Jicarilla Apache Nation the sum of $2,853,974 and the MMS the sum of $1,224,043. MMS also retained certain overpayments by BROG in the amount of $1,127,623 as part of the settlement. Certain properties included in this settlement are burdened by the Royalty. BROG previously offset the entire $2,853,974 Jicarilla component of the settlement against amounts otherwise distributed in payment of the Royalty, and deducted $901,776 from the April 2003 distribution to the Trust as the Trust's 75% portion of the remaining $1,224,043 component of the settlement, slightly reduced by agreement of the parties. BROG has indicated that it does not appear that any of the $1,127,623 in overpayments retained by the MMS is attributable to the Royalty.
In June 2000, the Trust and BROG entered into a partial settlement of claims relating to a gas imbalance with respect to production from mineral properties currently operated by BROG. Under the terms of the partial settlement, BROG paid the Trust $3,490,000 to settle the imbalance insofar as it relates to some of the wells located on the Underlying Properties. The remainder of the imbalance is to be addressed through volume adjustments whereby the Trust's Royalty will be increased by the proceeds from 50% of the overproduced parties' interest, on a monthly basis, until the imbalance is corrected. The Trustee and its consultants remain in communication with BROG in order to determine the estimated value of the volume adjustments and the time during which the remainder of the imbalance will be corrected. BROG indicates that the volume adjustment commenced in August 2000. The Trust's consultants continue to monitor those adjustments.
ADMINISTRATIVE PROCEEDINGS
The following information was provided to the Trust by BROG. Please note that the proceedings described below apply to the collective interest of BROG and the Trust. BROG is not able to estimate the amount of any potential loss to the Trust in each of the outstanding proceedings, or the portion of any such potential loss that would be allocated to the Royalty.
MMS PROCEEDINGS
Blanco Pool. This appeal arises from a MMS Demand Letter dated October 20, 1995, and bears MMS Appeal Docket No. MMS-95-0740. The demand letter challenges the "valuation benchmark" utilized by BROG for gas sold by BROG from the "Blanco Pool" during the audit period of January 1, 1989 through December 31, 1991. BROG paid royalties on sales to its marketing affiliate based on "gross proceeds" received by BROG from its affiliate. The demand letter states that BROG paid incorrectly under MMS regulations. The MMS methodology in calculating the amounts demanded does not attempt to trace resale proceeds. Instead, MMS' auditors use published index prices at pipeline interconnect points in the San Juan Basin as a proxy for actual comparable sales, and net out certain actual costs to move the gas to those index points. While BROG had deducted prevailing field transportation rates in computing its monthly prices in the San Juan Basin, the auditors limited the deduction to the actual rate paid to El Paso Natural Gas under a "backhaul" agreement. The demand letter directs BROG to pay additional royalties of $518,304, to recalculate royalties in accordance with the MMS' interpretation of the regulations and to pay the difference between total royalty due and royalty paid.
Affiliate Proceeds Demand -- Conventional Gas. This appeal arises from a MMS demand letter dated June 9, 1997, and bears MMS Appeal Docket No. MMS-97-0168. The demand letter is a blanket demand relating to all of BROG's non-coalbed methane gas production nationwide for the audit period of January 1, 1989 through December 31, 1994. The demand letter is based primarily on the MMS theory that royalties are to be based on BROG's marketing affiliate gross proceeds rather than BROG's gross proceeds (e.g. the affiliate resale proceeds issue). The demand letter directs BROG to recalculate its royalties on these sales using a netback calculation of the proceeds of the affiliate, and pay the difference between total royalties due under such calculation and the royalties actually paid by BROG. This demand letter is in furtherance of the demand letter described in the prior paragraph.
Coalbed Methane. This appeal arises from a MMS demand letter dated October 28, 1996, and bears MMS Appeal Docket No. MMS-96-0437. The demand letter relates to BROG's coalbed methane production from the Northeast Blanco Unit for the audit period of May 1, 1990 through December 31, 1993, and from the San Juan 30-6 Unit for the audit period of January 1, 1989 through December 31, 1991. Like the Blanco Pool demand letter, the demand letter does not attempt to trace resale proceeds. The issues are whether MMS should bear its share of CO(2) extraction costs and, if so, whether the costs should be based on market rates or actual costs of the system, and whether MMS' share of transportation costs (which MMS does not dispute it must bear) should be based on market rates or actual costs of the system. BROG is directed to pay additional royalties of $3,600,584 for underpayment of royalty for gas produced from the units mentioned above, to recalculate royalties for gas produced from other federal leases in accordance with MMS' interpretation of the regulations and to pay the difference between total royalty due and royalty paid.
Due to the similarity of the claims in the Blanco Pool, Affiliate Proceeds Demand and the Coalbed Methane administrative appeals, to the claims in the suits in the In re Natural Gas Royalties qui tam litigation described below, settlement discussions between BROG and the federal government in the gas qui tam litigation will, if successful, include the settlement of each of the MMS Proceedings.
JICARILLA INDIAN TRIBE PROCEEDINGS
This appeal arises from an MMS Order to Perform dated June 10, 1998. The Order to Perform states that, in valuing production for royalty purposes, BROG must, among other things, perform a major portion analysis (i.e., calculate value on the highest price paid or offered for a major portion of the gas produced from the field where the leased lands are situated). BROG believes that producers do not have access to prices received by other producers in a field, so a major portion calculation must be done by MMS.
LITIGATION
GRYNBERG LITIGATION
In September 1998, BROG was advised by the United States Department of Justice under an order of confidentiality that a lawsuit styled United States of America ex rel Jack J. Grynberg v. Burlington Resources Oil & Gas, et al., Civil Action No. 97-CV-189 and 190, United States District Court for the District of Wyoming, had been filed under seal pursuant to the qui tam provisions of the civil federal False Claims Act, and that seventy-seven similar cases had been filed by the plaintiff against other companies. The complaint alleges that BROG engaged in the mismeasurement of volumes and wrongful analysis of heating content of natural gas and engaged in other activities, including the sale of natural gas to affiliated companies, which resulted in the underpayment of royalties to the United States. The government investigated the plaintiff's claims, and in May 1999 issued notice that the United States would not intervene in the case. The lawsuits have been unsealed by the court and the plaintiff has served the complaint on BROG. This claim was subsequently consolidated into a multi-district litigation proceeding as described below.
IN RE NATURAL GAS ROYALTIES QUI TAM LITIGATION
On March 28, 2000, the United States District Court for the Eastern District of Texas, Lufkin Division, ordered that the first amended complaint in the case of United States ex rel. M. Glenn Osterhoudt, III v. Amerada Hess, et al., Civil Action No. 9:98CV101, in the United States District Court for the Eastern District of Texas, Lufkin Division, and the second amended complaint in the case of United States of America ex rel. Harrold E. (Gene) Wright v. Agip Petroleum Burlington, et al., Civil Action No. C-5:96CV243 be unsealed and served upon defendants, including BROG. In these lawsuits, the plaintiffs have alleged violations of the civil False Claims Act. Plaintiffs contend that defendants underpaid royalties on natural gas and natural gas liquids produced on federal and Indian lands through the use of below-market prices, improper deductions, improper measurement techniques and transactions with affiliated companies. The United States has filed an intervention in these cases as to some of the defendants, including BROG.
In July 2000, the United States District Court for the District of New Mexico unsealed and BROG was served with the petition in United States of America ex rel. Mark A. Perry v. BROG Resources, Inc., et al., Civil Action No. 9:00CV197, in the United States District Court for the District of New Mexico, wherein plaintiff alleges violations of the civil False Claims Act. The plaintiff claims that BROG understated the value of natural gas and natural gas liquids produced on federal and Indian lands in connection with its computation and reporting of royalty payments. The United States has elected to intervene in this case, but a complaint has not been served upon BROG.
In October 2000, the federal Judicial Panel on Multidistrict Litigation ordered that the Wright and Osterhoudt lawsuits be transferred to the United State District Court for the District of Wyoming for inclusion with the Grynberg lawsuit described above in multidistrict litigation proceedings. A similar order was issued in December 2000 transferring the Perry lawsuit. These cases have been consolidated for pre-trial proceedings in the matter styled In re Natural Gas Royalties Qui Tam Litigation, MDL-1293, United States District Court for the District of Wyoming.
If successful, this litigation could result in a decrease in royalty income received by the Trust. At this time, no estimate can be made as to the amount of any potential loss in this litigation, or the portion of any such potential loss that would be allocated to the Trust's interest. Any proposed allocation of loss to the Trust will be reviewed by the Trust's consultants.
QUINQUE LITIGATION
In September 1999, BROG was served with a class action petition styled Quinque Operating Company on behalf of Gas Producers v. Gas Pipelines, et al., Case No. 99 C 30, in the District Court of Stevens County, Kansas, naming certain of its current or former affiliates as defendants, along with hundreds of other gas production and gas pipeline companies. On February 21, 2002, the District Court granted leave for plaintiffs to file a third amended class action petition substituting in new class representative plaintiffs thereby changing
the style of the case to Will Price, Stixon Petroleum, Inc. and Thomas F. Boles on behalf of Gas Producers v. Gas Pipelines, et al., Case No. 99 C 30, in the District Court of Stevens County, Kansas. The petition alleges that the defendants engaged in the mismeasurement of volumes and wrongful analysis of heating content of natural gas and engaged in other activities which resulted in the underpayment of revenue owed to working interest owners, royalty interest owners, overriding royalty interest owners and state taxing authorities. If successful, this litigation could result in a decrease in royalty income received by the Trust. At this time, no estimate can be made as to the amount of any loss in this litigation, or the portion of any such potential loss that would be allocated to the Trust. Any proposed allocation of loss to the Trust will be reviewed by the Trust's consultants.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
(4)(a) Amended and Restated Royalty Trust Indenture, dated
September 30, 2002 (the original Royalty Trust Indenture,
dated November 1, 1980 having been entered into between
Southland Royalty Company and The Fort Worth National Bank,
as Trustee) heretofore filed as Exhibit 99.2 of the Trust's
Current Report on Form 8-K filed with the SEC on October 1,
2002, is incorporated herein by reference.*
(4)(b) Net Overriding Royalty Conveyance from Southland Royalty
Company to the Fort Worth National Bank, as Trustee, dated
November 3, 1980 (without Schedules), heretofore filed as
Exhibit 4(b) to the Trust's Annual Report on Form 10-K filed
with the SEC for the fiscal year ended December 31, 1980, is
incorporated herein by reference.*
(4)(c) Assignment of Net Overriding Interest (San Juan Basin
Royalty Trust), dated September 30, 2002, between Bank One,
N.A. and TexasBank heretofore filed as Exhibit 4(c) to the
Trust's Quarterly Report on Form 10-Q with the SEC for the
quarter ended September 30, 2002, is incorporated herein by
reference.*
10(a) Indemnification Agreement, dated May 13, 2003, with
effectiveness as of July 30, 2002 by and between Lee Ann
Anderson and San Juan Basin Royalty Trust.**
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* A copy of this Exhibit is available to any Unit Holder (free of charge) upon written request to the Trustee, TexasBank, 2525 Ridgmar Boulevard, Suite 100, Fort Worth, Texas 76116.
** Filed herewith.
(b) Reports on Form 8-K.
The Trust filed a report on Form 8-K on February 25, 2003. In the report, the Trust reported, under Item 5, that on February 10, 2003, it had issued a press release announcing the capital project plan for 2003 as delivered to it by BROG as well as revisions to the 2002 capital budget estimate.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
TEXASBANK, AS TRUSTEE FOR
THE SAN JUAN BASIN ROYALTY TRUST
By: /s/ LEE ANN ANDERSON
------------------------------------
Lee Ann Anderson
Vice President and Trust Officer
Date: May 15, 2003
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(The Trust has no directors or executive officers.)
CERTIFICATION
I, Lee Ann Anderson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of San Juan Basin Royalty Trust, for which TexasBank acts as Trustee;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, distributable income and changes in trust corpus of the registrant as of, and for, the period presented in this quarterly report;
4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14), or for causing such procedures to be established and maintained, for the registrant and I have:
(a) designed such disclosure controls and procedures, or caused such controls and procedures to be designed, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the registrant's auditors:
(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves persons who have a significant role in the registrant's internal controls; and
6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
In giving the certifications in paragraphs 4, 5 and 6 above, I have relied to the extent I consider reasonable on information provided to me by Burlington Resources Oil & Gas Company LP.
TEXASBANK, AS TRUSTEE FOR THE
SAN JUAN BASIN ROYALTY TRUST
By: /s/ LEE ANN ANDERSON
------------------------------------
Lee Ann Anderson
Vice President and Trust Officer
Date: May 15, 2003
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
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(4)(a) Amended and Restated Royalty Trust Indenture, dated
September 30, 2002 (the original Royalty Trust Indenture,
dated November 1, 1980 having been entered into between
Southland Royalty Company and The Fort Worth National Bank,
as Trustee) heretofore filed as Exhibit 99.2 of the Trust's
Current Report on Form 8-K filed with the SEC on October 1,
2002, is incorporated herein by reference.*
(4)(b) Net Overriding Royalty Conveyance from Southland Royalty
Company to the Fort Worth National Bank, as Trustee, dated
November 3, 1980 (without Schedules), heretofore filed as
Exhibit 4(b) to the Trust's Annual Report on Form 10-K filed
with the SEC for the fiscal year ended December 31, 1980, is
incorporated herein by reference.*
(4)(c) Assignment of Net Overriding Interest (San Juan Basin
Royalty Trust), dated September 30, 2002, between Bank One,
N.A. and TexasBank heretofore filed as Exhibit 4(c) to the
Trust's Quarterly Report on Form 10-Q with the SEC for the
quarter ended September 30, 2002, is incorporated herein by
reference.*
10(a) Indemnification Agreement, dated May 13, 2003, with
effectiveness as of July 30, 2002 by and between Lee Ann
Anderson and San Juan Basin Royalty Trust.**
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* A copy of this Exhibit is available to any Unit Holder (free of charge) upon written request to the Trustee, TexasBank, 2525 Ridgmar Boulevard, Suite 100, Fort Worth, Texas 76116.
** Filed herewith.
EXHIBIT 10(a)
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INDEMNIFICATION AGREEMENT
This INDEMNIFICATION AGREEMENT (the "Agreement") is made and entered into as of the 13th day of May, 2003, with effectiveness as of July 30, 2002, by and between San Juan Basin Royalty Trust, a trust organized under the laws of the State of Texas (including any successors thereto, the "Trust"), and Lee Ann Anderson ("Indemnitee").
RECITALS:
1. TexasBank, a bank chartered under the laws of the State of Texas (the "Bank"), serves as trustee of the Trust pursuant to the terms of that certain Amended and Restated Royalty Trust Indenture, dated September 30, 2002, between Burlington Resources Oil & Gas Company LP and the Bank (the "Indenture").
2. Indemnitee is an officer of the Bank and is primarily responsible for managing the day-to-day activities of the Trust.
3. Competent and experienced persons (such as Indemnitee) are reluctant to serve or to continue to serve institutions (such as the Trust and the Bank) as directors, officers, or in other capacities unless they are provided with adequate protection through insurance or indemnification (or both) against claims and actions against them arising out of their service to and activities on behalf of those institutions.
4. The current uncertainties relating to the availability of adequate insurance have increased the difficulty for institutions to attract and retain competent and experienced persons.
5. The reluctance of knowledgeable and experienced persons to serve institutions has increased since the passage of the Sarbanes-Oxley Act on July 30, 2002, which imposed additional civil and criminal penalties for such persons acting in their individual capacities.
6. The Bank, in its capacity as trustee of the Trust, has determined that the continuation of present trends in litigation will make it more difficult to attract and retain competent and experienced persons to manage the day-to-day affairs of the Trust, that this situation is detrimental to the best interests of the Trust's unit holders, and that the Trust should act to assure the employees of the Bank who manage the operations of the Trust, including the Indemnitee, that there will be increased certainty of adequate protection in the future.
7. It is reasonable, prudent, and necessary for the Trust to obligate itself contractually to indemnify the employees of the Bank who manage the operations of the Trust, including the Indemnitee, to the fullest extent permitted by applicable law in order to induce them to serve or continue to serve the Trust.
8. Indemnitee is willing to serve and continue to serve the Trust on the condition that she be indemnified to the fullest extent permitted by law, including, but not limited to, any actions taken individually on behalf of the Trust or for the Bank in its capacity as trustee of the Trust.
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AGREEMENTS:
NOW, THEREFORE, in consideration of the foregoing premises, Indemnitee's agreement to serve or continue to serve as a director or officer of the Bank and to be primarily responsible for managing the day-to-day activities of the Trust, and the covenants contained in this Agreement, the Trust and Indemnitee hereby covenant and agree as follows:
1. Certain Definitions.
For purposes of this Agreement:
(a) Affiliate: shall mean any Person that directly, or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with the Person specified.
(b) Change of Control: shall mean the occurrence of any of the following events:
(i) The acquisition after the date of this Agreement by any individual, entity, or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934 (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 50% or more of the units of beneficial interest of the Trust (the "Outstanding Units");
(ii) TexasBank ceases for any reason to be the trustee of the Trust; or
(iii) Consummation of a sale, lease, exchange, or other disposition of all or substantially all of the assets of the Trust to any Person.
(c) Claim: shall mean any threatened, pending, or completed action, suit, or proceeding (including, without limitation, securities laws actions, suits, and proceedings and also any cross claim or counterclaim in any action, suit, or proceeding), whether civil, criminal, arbitral, administrative, or investigative in nature, or any inquiry or investigation (including discovery), whether conducted by the Trust or any other Person, that Indemnitee in good faith believes might lead to the institution of any action, suit, or proceeding.
(d) Expenses: shall mean all costs, expenses (including attorneys' and expert witnesses' fees), and obligations paid or incurred in connection with investigating, defending (including affirmative defenses and counterclaims), being a witness in, or participating in (including on appeal), or preparing to defend, be a witness in, or participate in, any Claim relating to any Indemnifiable Event.
(e) Indemnifiable Event: shall mean any actual or alleged act, omission, statement, misstatement, event, or occurrence arising out of or related to Indemnitee's day-to-day management of the Trust's affairs, or by reason of any actual or alleged thing done or not done by Indemnitee in any such capacity (i) on behalf of the Trust or the Bank in its capacity as trustee of the Trust or (ii) for the benefit of the Trust or the Trust's unit holders while the Bank is trustee of the Trust.
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(f) Indemnifiable Liabilities: shall mean all Expenses and all other liabilities, damages (including, without limitation, punitive, exemplary, and the multiplied portion of any damages), judgments, payments, fines, penalties, amounts paid in settlement, and awards paid or incurred that arise out of, or in any way relate to, any Indemnifiable Event.
(g) Potential Change of Control: shall be deemed to have occurred if
(i) the Trust enters into an agreement, the consummation of which would result
in the occurrence of a Change of Control or (ii) any Person publicly announces
an intention to take or to consider taking actions that, if consummated, would
constitute a Change of Control.
(h) Reviewing Party: shall mean (i) an officer of the Bank (acting in its capacity as trustee of the Trust) who is not a party to the particular Claim for which Indemnitee is seeking indemnification or (ii) if a Change of Control has occurred and Indemnitee so requests, or if the Bank in its capacity as trustee of the Trust so elects, or if the Bank is a party to such Claim, Special Counsel.
(i) Special Counsel: shall mean special, independent legal counsel selected by Indemnitee and approved by the Trust (which approval shall not be unreasonably withheld), and who has not otherwise performed material services for the Trust or for Indemnitee within the last three years (other than as Special Counsel under this Agreement or similar agreements).
2. Indemnification and Expense Advancement.
(a) The Trust shall indemnify Indemnitee and hold Indemnitee harmless to the fullest extent permitted by law, as soon as practicable but in any event no later than 30 days after written demand is presented to the Trust, from and against any and all Indemnifiable Liabilities. Notwithstanding the foregoing, the obligations of the Trust under Section 2(a) shall be subject to the condition that the Reviewing Party shall not have determined (in a written opinion, in any case in which Special Counsel is involved) that Indemnitee is not permitted to be indemnified under applicable law. Any determination under this Section 2(a) shall be made promptly by the Reviewing Party.
(b) If so requested by Indemnitee, the Trust shall advance to Indemnitee all reasonable Expenses incurred by Indemnitee to the fullest extent permitted by law (or, if applicable, reimburse Indemnitee for any and all reasonable Expenses incurred by Indemnitee and previously paid by Indemnitee) within ten business days after such request (an "Expense Advance"). The Trust shall be obligated from time to time at the request of Indemnitee to make or pay an Expense Advance in advance of the final disposition or conclusion of any Claim. In connection with any request for an Expense Advance, if requested by the Trust, Indemnitee or Indemnitee's counsel shall submit an affidavit stating that the Expenses to which the Expense Advances relate are reasonable. Any dispute as to the reasonableness of any Expense shall not delay an Expense Advance by the Trust. If, when, and to the extent that the Reviewing Party determines that (i) Indemnitee would not be permitted to be indemnified with respect to a Claim under applicable law or (ii) the amount of the Expense Advance was not reasonable, the Trust shall be entitled to be reimbursed by Indemnitee and Indemnitee hereby agrees to reimburse the Trust without interest (which agreement shall be an unsecured obligation of Indemnitee) for (x) all related Expense Advances theretofore made or paid by the Trust in the event that it is
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determined that indemnification would not be permitted or (y) the excessive portion of any Expense Advances in the event that it is determined that such Expenses Advances were unreasonable, in either case, if and to the extent such reimbursement is required by applicable law; provided, however, that if Indemnitee has commenced legal proceedings in a court of competent jurisdiction to secure a determination that Indemnitee could be indemnified under applicable law, or that the Expense Advances were reasonable, any determination made by the Reviewing Party that Indemnitee would not be permitted to be indemnified under applicable law or that the Expense Advances were unreasonable shall not be binding, and the Trust shall be obligated to continue to make Expense Advances, until a final judicial determination is made with respect thereto (as to which all rights of appeal therefrom have been exhausted or lapsed), which determination shall be conclusive and binding. If there has been a Change of Control, the Reviewing Party shall be Special Counsel, if Indemnitee so requests. If there has been no determination by the Reviewing Party or if the Reviewing Party determines that Indemnitee substantively is not permitted to be indemnified in whole or part under applicable law or that any Expense Advances were unreasonable, Indemnitee shall have the right to commence litigation in any court in the state of Texas having subject matter jurisdiction thereof and in which venue is proper seeking an initial determination by the court or challenging any such determination by the Reviewing Party or any aspect thereof, and the Trust hereby consents to service of process and to appear in any such proceeding. Any determination by the Reviewing Party otherwise shall be conclusive and binding on the Trust and Indemnitee.
(c) Nothing in this Agreement, however, shall require the Trust to indemnify Indemnitee with respect to any Claim initiated by Indemnitee, other than a Claim solely seeking enforcement of the Trust's indemnification obligations to Indemnitee or a Claim authorized by the Bank acting in its capacity as trustee of the Trust.
3. Change of Control. The Trust agrees that, if there is a Potential Change in Control or a Change of Control and if Indemnitee requests in writing that Special Counsel be the Reviewing Party, then Special Counsel shall be the Reviewing Party. In such a case, the Trust agrees not to request or seek reimbursement from Indemnitee of any indemnification payment or Expense Advances unless Special Counsel has rendered its written opinion to the Trust and Indemnitee that the Trust was not or is not permitted under applicable law to indemnify Indemnitee or that such Expense Advances were unreasonable. However, if Indemnitee has commenced legal proceedings in a court of competent jurisdiction to secure a determination that Indemnitee could be indemnified under applicable law or that the Expense Advances were reasonable, any determination made by Special Counsel that Indemnitee would not be permitted to be indemnified under applicable law or that the Expense Advances were unreasonable shall not be binding, and the Trust shall be obligated to continue to make Expense Advances, until a final judicial determination is made with respect thereto (as to which all rights of appeal therefore have been exhausted or lapsed), which determination shall be conclusive and binding. The Trust agrees to pay the reasonable fees of Special Counsel and to indemnify Special Counsel against any and all expenses (including attorneys' fees), claims, liabilities, and damages arising out of or relating to this Agreement or Special Counsel's engagement pursuant hereto.
4. Indemnification for Additional Expenses. The Trust shall indemnify Indemnitee against any and all costs and expenses (including attorneys' and expert witnesses' fees) and, if requested by Indemnitee, shall (within two business days of that request) advance those costs and
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expenses to Indemnitee, that are incurred by Indemnitee if Indemnitee, whether
by formal proceedings or through demand and negotiation without formal
proceedings: (a) seeks to enforce Indemnitee's rights under this Agreement, (b)
seeks to enforce Indemnitee's rights to expense advancement or indemnification
under any other agreement, including, without limitation, the Indenture, now or
hereafter in effect relating to Claims for Indemnifiable Events, or (c) seeks
recovery under any directors' and officers' liability insurance policies
maintained by the Bank or the Trust, in each case regardless of whether
Indemnitee ultimately prevails; provided that a court of competent jurisdiction
has not found Indemnitee's claim for indemnification or expense advancements
under the foregoing clauses (a), (b) or (c) to be frivolous, presented for an
improper purpose, without evidentiary support, or otherwise sanctionable under
Federal Rule of Civil Procedure No. 11 or an analogous rule or law, and provided
further, that if a court makes such a finding, Indemnitee shall reimburse the
Trust for all amounts previously advanced to Indemnitee pursuant to this Section
4. Subject to the provisos contained in the preceding sentence, to the fullest
extent permitted by law, the Trust waives any and all rights that it may have to
recover its costs and expenses from Indemnitee.
5. Partial Indemnity. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Trust for some, but not all, of Indemnitee's Indemnifiable Liabilities, the Trust shall indemnify Indemnitee for the portion thereof to which Indemnitee is entitled.
6. Contribution.
(a) Contribution Payment. To the extent the indemnification provided for under any provision of this Agreement is determined (in the manner hereinabove provided) not to be permitted under applicable law, the Trust, in lieu of indemnifying Indemnitee, shall, to the extent permitted by law, contribute to the amount of any and all Indemnifiable Liabilities incurred or paid by Indemnitee for which such indemnification is not permitted. The amount the Trust contributes shall be in such proportion as is appropriate to reflect the relative fault of Indemnitee, on the one hand, and of the Trust and any and all other parties who may be at fault (collectively, including the Trust, the "Third Parties"), on the other hand.
(b) Relative Fault. The relative fault of the Third Parties and the Indemnitee shall be determined (i) by reference to the relative fault of Indemnitee as determined by the court or other governmental agency or (ii) to the extent such court or other governmental agency does not apportion relative fault, by the Reviewing Party after giving effect to, among other things, the relative intent, knowledge, access to information, and opportunity to prevent or correct the relevant events, of each party, and other relevant equitable considerations. The Trust and Indemnitee agree that it would not be just and equitable if contribution were determined by pro rata allocation or by any other method of allocation that does not take account of the equitable considerations referred to in this Section 6(b).
7. Burden of Proof. In connection with any determination by the Reviewing Party or otherwise as to whether Indemnitee is entitled to be indemnified under any provision of this Agreement or to receive contribution pursuant to Section 6 of this Agreement, to the extent permitted by law the burden of proof shall be on the Trust to establish that Indemnitee is not so entitled.
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8. No Presumption. For purposes of this Agreement, the termination of any Claim by judgment, order, settlement (whether with or without court approval), or conviction, or upon a plea of nolo contendere, or its equivalent, or an entry of an order of probation prior to judgment shall not create a presumption (other than any presumption arising as a matter of law that the parties may not contractually agree to disregard) that Indemnitee did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law.
9. Non-exclusivity. The rights of Indemnitee hereunder shall be in addition to any other rights Indemnitee may have under the Indenture or the laws of the State of Texas or otherwise. To the extent that a change in the laws of the State of Texas (whether by statute or judicial decision) permits greater indemnification by agreement than would be afforded currently under this Agreement, it is the intent of the parties hereto that Indemnitee shall enjoy by this Agreement the greater benefits so afforded by that change. Indemnitee's rights under this Agreement shall not be diminished by any amendment to the Indenture, or of any other agreement or instrument to which Indemnitee is not a party, and shall not diminish any other rights that Indemnitee now or in the future has against the Bank or the Trust.
10. Liability Insurance. Except as otherwise agreed to by the Trust and Indemnitee in a written agreement, to the extent the Trust maintains an insurance policy or policies providing directors' and officers' liability insurance, Indemnitee shall be covered by that policy or those policies, in accordance with its or their terms, to the maximum extent of the coverage available for any Person under such policy.
11. Period of Limitations. No action, lawsuit, or proceeding may be brought against Indemnitee or Indemnitee's spouse, heirs, executors, or personal or legal representatives, nor may any cause of action be asserted in any such action, lawsuit, or proceeding, by or on behalf of the Trust, after the expiration of two years after the statute of limitations commences with respect to Indemnitee's act or omission that gave rise to the action, lawsuit, proceeding, or cause of action; provided, however, that, if any shorter period of limitations is otherwise applicable to any such action, lawsuit, proceeding, or cause of action, the shorter period shall govern.
12. Amendments. No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any provision of this Agreement shall be effective unless in a writing signed by the party granting the waiver. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall that waiver constitute a continuing waiver.
13. Other Sources. Indemnitee shall not be required to exercise any rights that Indemnitee may have against any other Person (for example, under an insurance policy) before Indemnitee enforces his rights under this Agreement. However, to the extent the Trust actually indemnifies Indemnitee or advances her Expenses, the Trust shall be subrogated to the rights of Indemnitee and shall be entitled to enforce any such rights which Indemnitee may have against third parties. Indemnitee shall assist the Trust in enforcing those rights if it pays her costs and expenses of doing so. If Indemnitee is actually indemnified or advanced Expenses by any third party, then, for so long as Indemnitee is not required to disgorge the amounts so received, to that
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extent the Trust shall be relieved of its obligation to indemnify Indemnitee or advance Indemnitee Expenses.
14. Binding Effect. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the parties hereto and their respective successors, assigns (including any direct or indirect successor by merger or consolidation), spouses, heirs, and personal and legal representatives. This Agreement shall continue in effect regardless of whether Indemnitee continues to serve as an officer or director of the Bank or manage the day-to-day operations of the Trust.
15. Severability. If any provision of this Agreement is held to be illegal, invalid, or unenforceable under present or future laws effective during the term hereof, that provision shall be fully severable; this Agreement shall be construed and enforced as if that illegal, invalid, or unenforceable provision had never comprised a part hereof; and the remaining provisions shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance from this Agreement. Furthermore, in lieu of that illegal, invalid, or unenforceable provision, there shall be added automatically as a part of this Agreement a provision as similar in terms to the illegal, invalid, or unenforceable provision as may be possible and be legal, valid, and enforceable.
16. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Texas applicable to contracts made and to be performed in that state without giving effect to the principles of conflicts of laws.
17. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement.
18. Notices. Whenever this Agreement requires or permits notice to be given by one party to the other, such notice must be in writing to be effective and shall be deemed delivered and received by the party to whom it is sent upon actual receipt (by any means) of such notice. Receipt of a notice by the Bank shall be deemed receipt of such notice by the Trust.
19. Complete Agreement. This Agreement constitutes the complete understanding and agreement among the parties with respect to the subject matter hereof and supersedes all prior agreements and understandings between the parties with respect to the subject matter hereof, other than any indemnification rights that Indemnitee may enjoy under the Indenture or the laws of the State of Texas.
20. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but in making proof hereof it shall not be necessary to produce or account for more than one such counterpart.
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EXECUTED as of the date first written above.
SAN JUAN BASIN ROYALTY TRUST
BY: TEXASBANK, AS TRUSTEE
By: /s/ W. D. CRANZ, JR.
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Name: W. D. Cranz, Jr.
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Title: Executive Vice President
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INDEMNITEE
/s/ LEE ANN ANDERSON --------------------------------------------- LEE ANN ANDERSON |