Fractions


“Blood may be thicker than water, but oil is thicker than both.”  J. R. Ewing.

This family dispute among Ethel’s descendants arose when Ethel’s will employed double fractions in bequeathing royalty interests to her children. Did the instrument create a fixed fractional royalty or a floating fraction of royalty?

Straight to the takeaway

Don’t like math? Avoid a pop quiz by remembering, when describing a royalty conveyance:

  • Do not convey a fraction of a fraction unless that is what you intend to do. Why let ambiguity and confusion ruin your carefully crafted document?
  • Use language appropriate for the time and circumstances, but think ahead. Is change foreseeable in a way you can plan for?

If you don’t believe me read Hisaw v. Dawkins, from the Texas Supreme Court.

Times were different then

When Ethel’s will was written in 1947 Jackie Robinson was a rookie, LSU beat Texas A&M 19-13 (some things never change), and the standard royalty was 1/8th. Was that figure in Ethel’s will a synonym for the lessor’s royalty, or was the royalty interest fixed without regard for the possibility of a higher royalty in the future?

There were three separate parcels of land and each child received the surface and executive rights to one. Ethel’s will contemplated three scenarios for the royalty under all the tracts. Each child would receive:

  • an NPRI of an undivided 1/3rd of an undivided 1/8th of all oil, gas ….
  • 1/3rd of 1/8th royalty  …
  • 1/3rd of the remainder of the unsold royalty, if a conveyance occurred while she was alive.

Clarity from the Supreme Court

The court said it would not embrace a “mechanical approach” to a royalty conveyance that would require “rote multiplication of double fractions”. Bright line rules are arbitrary and will not always give effect to what the conveyance provides as a whole. The court of appeals erred in construing each royalty provision in isolation.

In what it called an analytical approach, the court applied the four corners rule, and attempted to harmonize all provisions of the document. The court reaffirmed its commitment to a “holistic” approach to contract construction by ascertaining the parties’ intent from all words and all parts of the instrument. To harmonize would resolve apparent inconsistencies or contradictions in the document.

The third royalty clause governed. It clearly showed Ethel’s intention to equally divide the royalties among the three children. Each would receive a 1/3rd floating royalty, not a 1/24th fixed royalty (that is, 1/3rd of 1/8th).

The antiquated assumption that all future royalties would be 1/8th did not evidence Ethel’s intent. This is not to say that reference to 1/8th won’t ever mean just that. It might, if the language is clear and unambiguous.

 Prince RIP. His voice and an acoustic guitar are all you need to see what a force he was.

For the sake of conversation let’s say I burgle your trade secrets after failing to close a big deal that would have saved your company. I would be in big trouble, according to a bankruptcy court in In re TXCO Resources., Inc., a case study in treachery and self-dealing in the executive suite worthy of J.R Ewing at his most disgruntled.

This short summary of the 69-page opinion can’t do justice to the thorough discussion of the tort of misappropriation, including the definition and examples of trade secrets in the oil patch and their significance in the development of unexplored areas (pp. 22–44), the scope of trade secret protection (pp. 53-54), ways to measure damages (pp. 55-66) and an interesting journey through the life-cycle of a south Texas oil prospect.

TXCO Seeks a Buyer

TXCO held leases on one million acres in southwest Texas. It was 2008 (think $147 per barrel to $35), and TXCO’s financial status became precarious. Peregrine Petroleum showed interest in acquiring TXCO’s assets. TXCO provided confidential information in several stages so that Peregrine could evaluate the deal.

The trade secrets were typical of an E&P company’s confidential information: subsurface data, production data, and operations data. The parties were unable to reach an agreement, and TXCO filed for bankruptcy. TXCO lost its leases and attempted reacquire them and other leases nearby, but the owners leased to Peregrine instead. (You can see where this is going).

TXCO Proves Misappropriation

Suspecting that Peregrine had used the confidential information, TXCO sued for misappropriation of trade secrets, breach of contract, tortious interference, violations of the Texas Theft Liability Act, and unfair competition by misappropriation. The evidence showed that Peregrine had taken the trade secrets and used them to acquire leases that TXCO once owned. Peregrine was liable for misappropriating the data by using it to make leasing decisions.

See pages 45 to 52 for a handy guide on how to steal trade secrets.

And $15,873.383 in Damages

TXCO could not prove lost profits because of its precarious financial situation. TXCO never fulfilled its lease commitments, and several mineral owners testified that they would not have re-leased to TXCO. Furthermore, because the amount of potential production from the leases could not be accurately predicted, TXCO could not prove lost profits proximately caused by Perregrine’s theft to a reasonable certainty.

The court then examined the value of the data to Peregrine. The court did not use Peregrine’s profits as a measure, because Peregrine had not actually produced hydrocarbons. But the court stated that the “lack of actual profits does not insulate the defendants from being obligated to pay for what they have wrongfully obtained in the mistaken belief their theft would benefit them”.  And to recover on this theory does not require the victim to prove a specific injury.

To determine the value of the data to Peregrine, the Court imposed a “reasonable royalty”. The court determined what a fair price for the information would have been at the time the misappropriation occurred. Because the type of information obtained by Peregrine is typically acquired in an exploration agreement, the appropriate measure of damages was “the amount Peregrine would have spent drilling the wells to earn acreage under an exploration agreement with TXCO, discounted by the 50% working interest that Peregrine would have carried.”

 Based on this analysis, the court awarded TXCO $15,873,383. 

The court denied recovery for tortious interference-with-prospective-contractual relations because TXCO could not prove that it would have obtained the leases absent Peregrine’s misconduct. Recall that the mineral owners were reluctant to deal with TXCO because of its financial status, and they had received better offers from other parties.

The Court denied recovery for the other claims because TXCO was unable to prove damages.

Today’s appropriate musical interlude.  I couldn’t find the Allman Brothers’ versionfo ths song, but Elmore James is pretty good.