September 19, 2018
Author: Richard M. Butler
Organization: Langley, Banack & Butler
In spite of popular belief that the Texas Supreme Court had foresworn “judicial activism” and made great efforts to reduce the number of lawsuits filed in Texas and the likelihood of their success, the Supreme Court has taken a somewhat different approach when it comes to breach of fiduciary duty causes of action asserted by mineral and royalty interest owners against those who hold the executive rights to those interests. In this article, we will examine the uncertain and treacherous landscape upon which executive rights holders must tread in view of the Supreme Court’s decision in Lesley v. Veterans Land Board of State, 352 S.W.2d 479 (Tex. 2011).
THE RIGHTS OF THE EXECUTIVE RIGHTS HOLDER
The mineral estate in a piece of land was always referred to by my oil and gas professor, the late Edwin Horner, as a “bundle of sticks,” a description also used by just about every other past and present oil and gas professor in the State of Texas and by many courts. The sticks in the bundle include (1) the right to develop, (2) the right to lease (the executive right), (3) the right to receive bonus payments, (4) the right to receive delay rental payments, and (5) the right to receive royalty payments. French v. Chevron USA, Inc., 896 S.W.2d 795, 797 (Tex. 1995); Altman v. Blake, 712 S.W.2d 117 (Tex. 1986). Each attribute is an independent property right that may be severed, conveyed, or reserved. French v. Chevron USA, Inc. The Texas Supreme Court reiterated the definition of the executive right as “the right to make decisions affecting the exploration and development of the mineral estate… most commonly exercised by executing oil and gas leases” in Lesley v. Veterans Land Board of State, 352 S.W.2d 479 (Tex. 2011).
The executive right is not simply the right to be the person who puts pen to paper on a mineral lease. As stated in Lesley, it is the right to make decisions regarding the mineral estate. In Hlavinka v. Hancock, 116 S.W.3d 412, 420-421 (Tex. App.—Corpus Christi 2003, disapproved on other grounds), the executive rights owner did not inform the non-executives of lease offers that the executive rights owner had received from oil and gas companies. The 13th Court of Appeals stated that the executive rights owner had the exclusive right to negotiate and make leases and that the non-executives had no right to participate in, or be informed of the negotiations.
Prior to Lesley, it was clear that the executive rights holder was entitled to insist on lease terms that would reasonably protect the surface of the property. Hawkins v. Twin Montana, Inc., 810 S.W.2d 441 (Tex. App.- Fort Worth 1991, no writ). As we will see, the Lesley decision puts that proposition in doubt.
While the executive rights holder appears to have the right to self-develop the oil and gas interests over which he holds the executive rights, doing so is a very perilous enterprise that almost guarantees a claim of self-dealing.
THE BURDENS OF THE EXECUTIVE RIGHTS HOLDER
The Texas Supreme Court first ventured into defining a duty owed by executive rights holders to non-executives in Schlittler v. Smith, 101 S.W.2d 543 (Tex. 1937). The Court stated that the executive should exercise “the utmost fair dealing” with respect to the non-executive’s royalty interest when leasing the property. Courts of Appeals after Schlittler found an array of actions that executive owners could not get away with in view of the Supreme Court’s rulings. One of the classic examples of an effort to thwart the interest of the non-executive mineral interest owners was undertaken by the executive in Portwood v. Buckalew, 521 S.W.2d 904 (Tex. Civ. App. - Tyler 1075). In that case, the executive rights holders secured leases which paid the executive rights holders large amounts of “overriding royalties” and cash per leased acre payments for what was purportedly surface damages payments, which amounts were not tied to the actual amount of damage caused by drilling operations and were not to be shared by the nonexecutives.
The Tyler Court found that these payments were way out of the ordinary for payments of surface damages and in fact constituted disguised bonus and royalty. The actions of the executives in making such leases constituted a breach of their obligation to exercise utmost fair dealing to protect the interest of the non-executives.
The Supreme Court again addressed the issue in Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984). In that case, Clinton Manges held all executive rights in a large south Texas ranch. The Guerra family retained roughly half of the mineral estate in the ranch, without the executive rights, which had been conveyed to Manges along with the other one half of the minerals. Manges thus owned roughly half of the minerals and the executive rights to the minerals he owned and the minerals owned by the Guerras, creating a co-tenancy in the mineral estate. In a complicated series of transactions, Manges subjected his mineral interest in the ranch to a lien securing a loan he received from a commercial lender which allegedly made it difficult or impossible to lease the property. Manges then leased a portion of the ranch to himself, as lessee, for the princely sum of $5 in total bonus, with a 1/8 royalty and ten year term. In affirming a judgment rendered against Manges for breaching the duty of utmost good faith and fair dealing owed by the executive rights holder, the Court stated that the duty of utmost good faith owed by an executive had been settled law since the Schlittler decision had been handed down in 1937, and that it had been followed in numerous courts of civil appeals decisions since that time. Interestingly, the Court then referred to the duty as a “fiduciary duty” which arose by virtue of the relationship between the parties. The fiduciary duty “requires the holder of the executive right, Manges in this case, to acquire for the nonexecutive every benefit that he exacts for himself.” The Court held that Manges had violated the fiduciary duty by agreeing upon a $5 nominal bonus for a lease of a portion of the ranch, and in dealing with the entire mineral interest so that he received benefits that the non-executives did not receive, such as all rights in the working interest of the Manges-to-Manges lease.
Although not discussed at length by the Manges Court, The Guerras recovered damages for not only losses due to the Manges-to-Manges lease, but also for losses of bonus and delay rental money that the Guerras allege were caused by Manges’ failure to negotiate leases with third parties for the balance of the ranch acreage. The speculation that the Texas Supreme Court had expanded the duty of the executive to include a “duty to lease,” however, seemed to be put to rest in 2003 when the Texas Supreme Court decided In re Bass, 113 S.W.3d 735 (Tex. 2003). In that case, Lee Bass owned the surface of the 22,000 acre La Paloma Ranch in south Texas and exclusive executive rights to all of the mineral estate. Bass had possession of seismic data that he had purchased from Exxon, who had conducted seismic operations on La Paloma and developed the data with his permission. The non-executive royalty interest owners contended that Bass was attempting to force them to sell their royalty interests to him and was refusing to lease the minerals for that reason. The non-executives contended that this refusal to lease was a breach of the implied duty to develop the minerals and a breach of the Manges fiduciary duty and sought to obtain production of the seismic data as evidence thereof. Bass resisted on the grounds that the seismic data was confidential trade secret material protected from discovery and that plaintiffs had failed to demonstrate that either cause of action was supportable. The Court held that the seismic data was a trade secret and that the royalty owners had failed to establish the existence of a claim against Bass to justify compelling production of the data. The Court held that no implied covenant or duty to develop the land arose when Bass acquired La Paloma by a typical warranty deed. The Court went on to state that it saw “no reason today to imply such a covenant as doing so would potentially place so many Texas landowners in a position of owing a duty to remote royalty interest holders that would burden fee simple estates in a manner contrary to traditional property law.” The Court then addressed plaintiffs’ claim that Manges and Schlittler give rise to a fiduciary duty of good-faith and fair-dealing to develop the mineral estate. The Court held that the duty spelled out in Smith has no application in Bass because “no lease has been executed and no royalty payment exists.” The Court went on to hold that it had held that Manges violated his fiduciary duty “by making a lease to himself under numerous unfair terms.” The Court concluded that what Bass owed the plaintiffs was to acquire for them every benefit he acquired for himself, and that since no lease was ever made, “Bass has yet to exercise his rights as the executive.” Since Bass has not executed a lease to himself or anyone else, no duty had been breached.
What seemed to be a well-settled matter of law, that the executive rights holder owed no fiduciary duty to non-executives unless and until a lease was made, was followed by the courts of appeals in Hlavinka v.Hancock, 116 S.W.3d 412 (Tex. App.- Corpus Christi 2003, disapproved), Aurora Petroleum, Inc. v. Newton, 287 S.W.3d 373 (Tex. App.- Amarillo 2009, disapproved), and Lesley v. Veterans Land Board of State, 281 S.W.2d 602, 619 (Tex. App.—Eastland 2009, reversed). All that apparent certainty came crashing down when the Texas Supreme Court reversed course in its Lesley decision.
THE UNCERTAINTY OF THE QUASI-FIDUCIARY DUTY OWED BY THE EXECUTIVE RIGHTS HOLDER POST-LESLEY
Bluegreen Southwest One, L.P., a property developer, acquired about 4,100 acres southwest of Fort Worth (“the Property”) that it developed into a high-end residential subdivision. Bluegreen acquired the surface, an undivided mineral interest, and exclusive executive rights to all mineral interests in the Property.
Bluegreen added certain restrictive covenants to protect the integrity of its residential subdivision, including a provision forbidding “commercial oil drilling, oil development operations, oil refining, quarrying or mining operation” on property in the subdivision. Bluegreen then conveyed the lots within its subdivision to some 1,700 lot owners, including in the conveyances all minerals in the lots, subject to the previously reserved minerals and the restrictive covenants. Exploration of the Barnett Shale commenced in the area of the subdivision at about the same time. Almost all properties surrounding the subdivision were subsequently leased for minerals. Two of the nonexecutive mineral interest owners sued Bluegreen and the individual lot owners in the subdivision under various theories contending that the restrictive covenants were a violation of the executive rights holder’s duty to the non-executive mineral interest owners. The Court of Appeals ruled that, in accordance with the holding of In re Bass, since no lease had been executed, no violation of the duty could have occurred.
The Court noted in its factual recitation that large portions of the Property could not be developed for oil and gas if drilling within the confines of the subdivision were prohibited, that the Property sat on perhaps $610,000,000 worth of hydrocarbons, and that some the non-executive mineral interest owners reserved their interests long before anyone ever contemplated putting a residential subdivision on the Property. If you think those “public policy” sounding recitations sound like the developer is being teed-up, you would be correct. The Texas Supreme Court then proceeds to attempt to navigate around the holding of In re Bass without overruling the case or even criticizing it, leaving a great deal of uncertainty and case-by-case factual analysis in its wake.
The Court begins its analysis by stating the obvious, that most of the revenue derived by mineral interest owners comes through mineral leasing. The Court observes that if the exclusive right to lease minerals could be exercised arbitrarily, the executive could “destroy all value in the non-executive interest, appropriating all benefits for himself or others” (emphasis added). The question arises, if the executive rights owner does not lease the mineral interest and no benefits are derived for the executive or others, why would a refusal to lease, arbitrary or otherwise, be actionable? Isn’t that exactly what the Bass Court was saying? The Supreme Court quickly cures this mystery by saying that it is “difficult to determine precisely what duty the executive owes the nonexecutive interest.”
The Texas Supreme Court finds that Bass cannot be interpreted as shielding the executive from all liability for inaction. “If the refusal is arbitrary or motivated by selfinterest to the non-executive’s detriment, the executive may have breached his duty.” The Court goes on to muddle the law further by declaring that “we need not decide whether as a general rule an executive is liable to a non-executive for refusing to lease minerals, if indeed a general rule can be stated, given the widely differing circumstances in which the issue arises. Bluegreen did not simply refuse to lease the minerals in the 4,100 acres; it exercised its executive right to limit future leasing by imposing restrictive covenants on the subdivision.” Does this language mean that an affirmative act which limits or precludes leasing is required to subject the executive rights holder to liability for failing to lease?
The Lesley decision limits the “fiduciary duty” of the executive rights holder in a significant way by stating that the executive does not have to sub-serve his own interest to that of the non-executive, as is the case in pure fiduciary relationships such as principal-agent. See also Mims v. Beall, 810 S.W.2d 876 (Tex. App. - Texarkana 1991, no writ). If the executive rights holder is not required to place the interest of the nonexecutive ahead of his own, doesn’t that allow the executive to enter into, or refuse to enter into leases based on self-interest?
Another problem posed by Lesley for oil and gas practitioners arises in the Court’s discussion of the interest of an executive rights holder in protecting the surface estate. The Court recognizes in its decision that Bluegreen’s efforts to protect the subdivision from intrusive and disruptive surface activities associated with oil and gas development activities, but dismisses these concerns by stating that “the common law provides appropriate protection to the surface owner through the accommodation doctrine.” Should this statement be read to mean that negotiating for surface protection clauses in an oil and gas lease, which could be said to reduce the value of the lease to prospective lessees, could be a violation of the fiduciary duty owed to a non-executive? If the accommodation doctrine provides “appropriate protection” for the surface estate, is insisting on more protection than the doctrine provides justifiable?
In view of the many open doors and unanswered questions left by the Lesley decision and the spike in leasing activity brought on by Eagle Ford and West Texas shale plays, it is safe to assume that a fair number of these executive rights duty cases will be winding their way through the trial courts and appellate courts of Texas. It will be interesting to see if the Supreme Court will revisit the issue in the near future to limit, expand or clarify its ruling.
REALITY SEMINAR EXAMPLES
1. Smith sells the Ranch to Jones. The Smith-Jones deed conveys all of the surface estate and all executive rights to Jones. The Smith-Jones deed also attempts to reserve a ½ non-executive mineral interest for Smith (as called for in the contract), but is so poorly worded that it is ambiguous as best, perhaps failing to reserve any mineral interest as a matter of law. Jones subsequently sells the ranch to Baker. The Jones-Baker deed reserves a non-participating mineral interest for Jones and is subject to the reservation of minerals for Smith contained in the Smith-Jones deed. Baker gets an offer to lease the Ranch for minerals from OMG. OMG tells Baker that its title research department has concluded that Smith reserved no minerals in the Smith-Jones deed and that all of the bonus and royalty is payable to Jones and Baker. Baker executes the lease and all bonus is paid to Baker and Jones. Did Baker breach the duty of utmost fair dealing by not insisting that OMG pay some portion of the Bonus to Smith? What would Baker’s duty of utmost fair dealing require Baker to do, if anything?
2. Olson owns the surface of Trophy Ranch and one-half of the minerals, including executive rights. The other one-half of the minerals, with executive rights are owned by Hart. Olson conveys to Falk the surface of Trophy Ranch, 5% of the minerals with executive rights, and the executive rights to the 45% mineral interest being reserved by Olson. Hart leases his ½ mineral interest to SSM for $1,750 per acre bonus, 25% royalty, and 3 year primary term. Olson hears about this deal and tells Falk that Falk should accept the same deal and lease all interests Falk has executive rights to for the same terms to SSM. Falk consults with SSM and is told that SSM will not negotiate any terms different than what it made with Hart, and that Falk has to lease his own interest, as well as the Olson interest, or the deal is off. Falk has heard it through the grape vine that lease prices will be elevating in the near future and decides to hold out for better terms. Is Falk potentially liable to Olson for refusing to lease? What would the damages be?
3. Joe owns 50% of the minerals in the Ranch and exclusive executive rights to 100% of the minerals. Sam and Larry each own an undivided 25% of the minerals, subject to Joe’s executive rights. Joe is approached by XMO and offered $1,000 bonus, 25% royalty, and 3 year primary term lease for all mineral interests in the property. Sam and Larry learn of the offer. Sam is in need of quick cash and tells Joe to take the deal. Larry thinks that a better offer will come if they wait and tells Joe to refuse the offer and wait. What happens if Joe takes the offer and shortly thereafter all the neighbors sign leases for $5,000 per acre. What happens if Joe rejects the offer, and thereafter a dry hole is drilled nearby and all leasing activity in the area blows away like dry west Texas sand? What if Joe had never heard from either Sam or Larry and never told them about the offer?