Most of the time, if you read Stroud et al v. Hosford et al. even Hamilton Burger might have won on these facts. But when a lease subject to an override is terminated and replaced by another, Texas cases usually end up against the overriding royalty owner.

The Holding:

The court agreed with the jury that the lessee intentionally terminated the lease to, in part, terminate the overrides. The question was whether that conduct is actionable under Texas law. The court reviewed Texas decisions on the subject and said that, even with what appeared to be bad faith, absent a relationship giving rise to a duty of good faith and fair dealing the override owners had no right to recover. The lessee doesn’t generally owe an implied contractual covenant or a fiduciary type duty to protect the interest of an override owner such as to require the lessee to make repairs to well equipment, perpetuate the lease, and ensure that overrides are not extinguished, and the lessee was not precluded by any contract from entering into a new lease.

The court acknowledged cases suggesting that a party that engages in conduct to intentionally wash out an override may be subject to liability. But the facts of this case did not support liability. The override owners have asked the Texas Supreme Court to review the decision. 

The (Simplified) Facts:

Do the facts get more “intentional” than these?

  • A few days after the lessee was notified that the ORRI owners didn’t have renewal and extension clauses, the well ceased to produce because of a mechanical defect (not caused by the lessee).
  • The lessee was advised by his lawyer that he had no obligation to pay the ORRI owners.
  • He knew he had a 90-day cessation of operations clause.
  • He didn’t order repairs on the well because, among other reasons, he had already offered interests in the property to other investors under other (new) leases.
  • There was no work during the 90 days and the lease terminated.
  • The lessee admitted that he intentionally returned the well to production after the lease had terminated and he had obtained a new lease.
  • He did it that way because he didn’t want overrides on the new lease.
  • The new lease was signed less than one month after the well ceased to produce and during the 90-day continuance operations period.
  • After the 90-day period expired, the lessee represented to potential investors that he intended to repair the broken well.
  • The well was repaired at a cost of $7,500 and production was resumed under the new lease.
  • The new lease and well were sold for $2.5 million.

The Dissent

The lone dissent appeared to be offended that such disregard for the rights of others could be rewarded.  Relying on lease provisions ignored by the majority and viewing some of the same cases differently, she would have reached a different result.  She also would have found that the lessee tortuously interfered with the override owners’ rights in the leases.

Where Do Override Owners Go Now? 

I’m sorry to say, it could be here.  

Thanks to Bill Drabble for his valuable assistance.

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.

Was it your long-time confidant who says your fiancee isn’t good enough for you and then runs off and marries her, or a seller’s remorse on a hundred-million dollar scale? We don’t know yet, but in Allen v. Devon Energy Holdings, a Houston court set guidelines for the trial of a case involving redemption of a member’s ownership interest in a limited liability company for a fraction of the amount he would have received in the sale of the entire company 20 months later.

This was an appeal of a summary judgment, not a trial, so no actual wrongdoing by anyone was established.

The facts are complicated and the legal analysis is detailed, which makes this post longer than usual. For lawyers, it is a quick treatise on the ins and outs of fraud claims and a warning that the “boilerplate” in your agreements might not be as effective as you think. For non-lawyers, it is about legal issues that could affect behavior among members of LLCs and shareholders of corporations, whether majority or minority owners.

Having tried in vain to avoid the turgid legalese non-lawyers have come to expect from people like me, I’ve inserted musical interludes about cheatin’ and betrayal that should help alleviate the stupefying boredom you are about to experience. For example:

 http://www.youtube.com/watch?v=9OIgZQj1aqs

 Enjoy!

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