The duty owed by the executive right holder to its non-participating royalty interest holder in Texas, long haunted by the ghost of Clinton Manges, is again examined. From KCM Financial, et al. v. Bradshaw and its precursors …

We Know This:

  • The executive owes the NPRI owner a duty of utmost good and fair dealing.
  • It is not a typical fiduciary relationship, in that the executive is not required to wholly subordinate its interests in favor of the non-executive.
  • The duty is one of autonomy, but not absolute discretion, to determine the value of the non-executive interest.
  • There is no bright line rule to comprehensively or completely delineate the boundaries of the executive’s duty.
  • The executive’s duty is to acquire for the non–executive every benefit that he exacts for himself.  That is not the same as putting the interests of the beneficiary ahead of the executive.
  • In evaluating whether an executive breached the duty, evidence of self-dealing can be pivotal. In the absence of self-dealing this court is not likely to find a breach of the duty.

The Facts:

The executive – KCM – granted an oil and gas lease with a below-market royalty shared equally by the executive and Ms. Bradshaw, the NPRI owner, in exchange for an above-market bonus payable only to KCM.  A 1960 deed creating the interest referenced reservation of an undivided one-half royalty, tied to the “customary“  1/8th royalty. The parties agreed that the NPRI is a fraction of the royalty that could float above the floor specified in the lease.

As we know, the customary royalty in the mid-2000’s was closer to a 1/4th than 1/8th.  KCM granted a lease reserving a 1/8th royalty and a bonus of $7,505 per acre. Bradshaw was entitled to 1/16th (half of the 1/8th), but none of the bonus.

As is usual in these cases, Manges v. Guerra came into play. That case is worth reading to see just how brazen and despicable an executive right holder can be and to see what “pervasive self-dealing “ looks like.

The Court’s Rationale:

Without the duty of good faith and fair dealing the actions of the executive could be exercised arbitrarily to in effect destroy all value of the non-executive’s interest, appropriating its benefit to the executive.

The court refused to conclude that the availability of a higher royalty rate could be categorically included in or excluded from the scope of the executive’s duty.  This is due to the myriad components of any given arrangement that could affect the overall value of any lease, including royalties, delay rentals, bonuses and other provisions.  Acquiring the same royalty in a lease does not automatically equate to acquiring the same benefit because of the bonus, in which the executive had no interest.

To the court, it will come down to whether the executive misappropriated what would have been a shared benefit (market value royalty) and converted it into a benefit reserved only to himself (an enhanced bonus).

There was enough evidence that could be self-dealing to return the case to the trial court.

What about the Lessee?

Out of space; tune in next week.

See our musical interlude for what every executive right holder should embrace.

The ghosts of Clinton Manges and people like him continue to haunt executive right owners in Texas. In the 1980’s, Mr. Manges’ abuse of his non-participating royalty owner inspired the Texas Supreme Court to re-affirm the obligations of an executive right owner to the NPRI owner: “utmost fair dealing” and a fiduciary duty.

In Friddle v. Fisher an appellate court went further and imposed on the executive right owner the duty to hold funds belonging to the NPRI owner in a constructive trust for the benefit of the NPRI owner.  The court considered this result to be a remedy for the executive’s breaches and not a duty in and of itself.

Friddle owned a 3/4ths NPRI in the mineral estate in an 84.7 acre tract of land in Hopkins County. Fisher, the owner of the executive right, leased the property. Valence Operating Company drilled an off-site well and pooled the tract into a unit. For nine years, the lessee paid Fisher the entire one-eighth royalty called for in the lease.

Friddle sued, alleging breach of fiduciary duty, unjust enrichment, and conversion. The court ruled in favor of Friddle, holding that Texas law imposes a duty of “utmost fair dealing” on the owner of the executive rights.

But there’s more! The executive owner’s traditional duty to acquire the same benefits for the non-executive interest that he acquires for himself is not his only duty. If he receives royalties rightfully belonging to the NPRI owner, he will be deemed to be acting as a constructive trustee with a duty to hold the funds which would be payable to the NPRI holder for the use and benefit of the NPRI holder.

The court also held that if the executive owner knows the NPRI holder’s name and whereabouts, the executive owner has a duty to notify the NPRI holder of any lease or any other agreement that affects the NPRI holder’s rights. The court did not go so far as to impose a duty on the executive holder to take steps to find the NPRI owner.

Based on the record before it, the court did not impose this liability on Fisher. There was conflicting evidence about whether Fisher knew Friddle’s identity or how to contact him or his predecessors in title. Accordingly, the court ordered a trial so that a jury could make that determination.

What about the NPRI owner’s duty to use reasonable diligence in protecting his interests, as expressed by the Supreme Court in 1998 in HECI v. Neel and its wicked spawn?  That duty was trumped by the executive-right owner’s fiduciary duty. (It’s not the concept in Neel that is odious; rather its application to the royalty owners under those facts was seen by many as unduly harsh). 

Based only on what the court said in this decision, at trial Fisher should be worried about the extent of his obligations, and Fiddle should be concerned about the statute of limitations.