The Texas Supreme Court recently issued an opinion addressing the duty owed by an executive right holder to non-participating mineral owners.  This is an important issue for both mineral owners and executive right holders to understand and be aware of when considering lease offers.

Factual Background

Dora Jo Carter owned 1,082 acres in Frio County.  She and her two children also, collectively, owned 50% of the mineral estate. The other 50% mineral interest was owned by the Hindeses.

In 2002,  Mrs. Carter sold the surface estate to Texas Outfitters Limited, LLC, whose owner planned to use the land as a residence and hunting operation.  In addition to the surface, Texas Outfitters also purchased a 4.16% mineral interest and the executive rights to the 45.84% mineral interest retained by Mrs. Carter and her children.  This left Texas Outfitters with the power to lease the 50% interest in the mineral estate that had been owned by the Carters and was now owned by the Carters and Texas Outfitters.  Texas Outfitters testified that they would not have purchased the land without the executive right.

In June 2010, the Hindeses leased their 50% mineral interest for a  $1,750/acre bonus and a 25% royalty.  The oil and gas company offered the same terms to Texas Outfitters for the remaining 50%.  Although the Carters wanted Texas Outfitters to accept this lease, Texas Outfitters rejected the offer and refused to lease the 50% of the minerals held by Carters and Texas Outfitters.  Texas Outfitters claimed they wanted to wait to see if better terms might be offered later.  Two additional leases were offered later, but both were withdrawn once the companies realized that the Hindeses’ 50% of the minerals were already leased.

The Carters filed suit alleging that Texas Outfitters breached the duty of utmost good faith and fair dealing it owed by virtue of owning the executive rights by refusing to enter into the lease agreement.

Both the trial court and court of appeals sided with the non-participating mineral owner in holding that Texas Outfitters violated their duty by refusing to lease the minerals.  The trial court awarded $867,654.32 (the amount the Carters would have received in bonuses were the offer accepted plus costs and interest).  The Court of Appeals affirmed.

Legal Background

Generally, if not severed, a mineral owner possesses certain rights as part of mineral ownership.  These rights include the executive right, which is the right to negotiate and enter into an oil and gas lease. Sometimes, however, these rights can be severed such that one person holds the executive right for all mineral owners in the tract who will receive the royalty negotiated by that executive rights holder.

For example, assume that A, B, and C each own a 1/3 undivided interest in 100 acres of mineral rights.  The general rule is that each A, B, and C hold their own executive right and can lease their portion to an oil or gas company as they wish.  If, however, A was granted all executive rights for the 100 acres in addition to his 1/3 interest, it would be up to A to negotiate and enter into any oil and gas leases for the property.  B and C would be “non-participating mineral owners” and essentially be left at A’s mercy.

In 2015, the Texas Supreme Court set forth the standard to examine the duty of an executive rights holder to non-participating royalty and mineral owners. [Read prior blog post.]  The court held that there is no bright-line rule, but that at minimum, the holder of an executive right is “prohibited from engaging in acts of self-dealing that unfairly diminish the value of the non-executive interest.”  This does not require the executive rights holder to “subjugate his interests to those of the non-executive; rather, the executive must acquire for the non-executive every benefit that he exacts for himself.”

Texas Supreme Court Opinion

The Supreme Court affirmed.  [Read opinion here.]

First, the Court noted that, generally, an executive does not breach the duty owed by declining a lease in honest anticipation of obtaining better terms for everyone.  However, there were other facts in this case at play as well.  Texas Outfitters knew that 50% of the minerals had already been leased, which greatly decreased the likelihood of additional leases being executed.  Further, Texas Outfitters owned only a small portion of the mineral estate, but owned all of the surface estate on which their business was run, potentially giving them an incentive not to want oil and gas production to occur.

Next, the Court noted that while not every executive owner primarily interested in the surface breaches his duty by engaging in conduct benefiting the surface and harming the mineral estate, there was sufficient evidence to support that finding here.  The fact that Texas Outfitters refused to lease, particularly given the lease of the other 50% of the minerals would decrease the potential lease opportunity, was important in reaching that conclusion.  As the Court explained, “Texas Outfitters gambled on a better lease offer despite knowing the circumstances that had made such an offer unlikely” and the risk of this gamble was much greater to the Carters than to Texas Outfitters given the sizes of their respective mineral interests.

Takeaways

Any executive right holder must be aware of the duty that he or she owes and consider how a decision to lease or not could potentially be viewed in light of that duty.  Non-participating mineral and royalty owners, too, should keep this standard in mind as they consider decisions made by their own executive.   The lack of a bright-line rule makes it difficult to predict how a court might view an executive’s action, but cases like this illustrate how courts will consider these issues and the key facts they rely upon to make their decisions.

For more information on oil and gas leasing, here is a link to our handbook titled Petroleum Production on Ag Lands in Texas, and here is a link to a podcast interview I did with Nicholas Miller on negotiating oil and gas leases.