Earlier this month, the San Antonio Court of Appeals issued two opinions in cases where the dispute centered around whether mineral reservations in a deed reserved a fixed or floating royalty. These cases offer important illustrations of the care that must be used when negotiating not only mineral leases, but also when negotiating the sale or reservation of mineral interests.
A mineral owner may create a royalty interest out of either the total production achieved under a lease or based upon the landowner’s royalty interest.
A royalty based upon a fixed fraction of total production (“fixed royalty”) is based upon a set fraction of production of minerals produced from the land, regardless of the percentage royalty that may be negotiated in a subsequent oil or gas lease. The fraction is set in the reservation and is not impacted by what royalty is included in an oil or gas lease. Thus, is one holds a 1/6 fixed royalty, he or she takes 1/6 of the gross production, regardless of what the lease might provide for. Examples of language creating a fixed royalty include: “A one-fourth royalty in all oil, gas, and other minerals”; “A fee royalty of 1/32 of the gas”; and “1% royalty of all oil and gas produced and saved.” Thus a fixed royalty is calculated by multiplying the fraction by total production. So, assuming a deed reserved a 1/8 fixed royalty, the holder would multiply total proceeds of the lease by 1/8.
A royalty based on a fraction of the total royalty interest (“floating royalty”) fluctuates based upon the royalty reserved in future leases. Basically, a floating interest creates for the holder a fraction of whatever royalty interest is reserved by the lessor of an existing or future mineral lease. Examples include: “1/16 of all oil royalty”; “the undivided 2/3 of all royalties”; and “one-half of the usual one-eighth royalty.” Thus, a floating royalty is calculated by multiplying the royalty fraction by the royalty rate agreed to in an oil and gas lease. So, assuming a deed reserved a 1/8 floating royalty and a lease later provided for a 1/4 royalty, the floating royalty would be 1/8 x 1/4, meaning that the royalty holder would get 1/8 of the 1/4 royalty being paid.
Medina Interests, LTD v. Trial
Annie Trial and her eight children owned 100% of the mineral and surface estate of land in Karnes County. In 1949, Mrs. Trial and six of her children (“the selling children”) sold their interest in the land to the other two children (“the purchasing children”), but reserved a royalty interest for the six selling children. Specifically, the deed conveying the property reserved “an undivided interest in and to the 1/8 royalties paid the land owner upon production of oil, gas and other minerals.” The deed went on to say that “the 1/8 royalties” paid to the purchasing children would be pooled and that all 8 children would share equally in the royalties received.
An oil and gas lease with Marathon was signed by Medina, successors in interest to the purchasing children. A dispute arose as to what type of interest was reserved. Medina argues that the deed reserved a fixed royalty of 1/8, meaning each of the 8 children hold a 1/8 interest in a 1/8 royalty. The selling children argue that they reserved a floating royalty of 1/8 out of an 8/8 royalty.
The trial court sided with the selling children, finding that the deed reserved a 1/8 floating royalty interest for each of the children.
The San Antonio Court of Appeals affirmed. The court noted that at the time the deed was executed, there was no existing lease in place and that in 1949, the usual royalty provided in a mineral lease was 1/8. Based on that, the court reasoned that the deed reference to “the 1/8 royalty” was based on the assumption that a landowner’s royalty would always be 1/8 under a mineral lease. Because there was no lease in place at the time of the deed, the court reasoned that the use of “the 1/8 royalty” must be interpreted as referring to whatever future royalty interest a landowner might reserve in a future lease, be that 1/8 or a different fraction, such as 1/4. The paragraph also referred to “royalties paid to the landowner” which is indicative of a floating royalty interest. Further, the fact that the lease repeatedly stated that royalties would be pooled and shared equally between the eight children is further evidence a floating royalty was intended.
Leal v. Cuanto Antes Mejor LLC
In this case, Phillip sold 40 acres of Karnes County land to the Leals. Philip reserved all minerals and royalties, except for conveying “a 1/4 non-participating royalty interest in and to all of the royalty paid on production” to the Leals. Philip later conveyed his mineral interest to Cuanto Antes Mejor LLC (“Cuanto”). An oil and gas lease was entered into that included the 40 acre property.
A dispute arose between Cuanto and the Leals about how the 1/4 royalty interest should be construed. Cuanto argued that the interest was a floating royalty interest, entitling them to 1/4 of all royalty paid on production, or 1/4 of 8/8 royalty. The Leals, on the other hand, argued the deed created a fixed royalty in 1/4 of production.
The trial court sided with Cuanto, finding it to be a floating royalty interest.
The San Antonio Court of Appeals affirmed. The court reasoned that the language “in and to all of the royalty” makes clear that the parties intended this to be a floating royalty as the payment would be based upon a fraction of the royalty actually received.
Why Should We Care?
Are you confused by the fine-line that distinguishes a fixed and floating royalty interest? Good. It’s a confusing concept that illustrates the importance and care that must be used anytime mineral interests are being conveyed, sold, reserved or leased. It is critical that parties dealing with mineral interests carefully ensure that their rights are protected and that they fully understand the impact of the language contained in the documents they are signing. I always recommend that an attorney review all legal documents, but this is especially important when mineral interests are at issue.