Remember the Wilford Brimley character in The Firm? “I get paid to be suspicious when I’ve got nothing to be suspicious about.” Shell Oil Company v. Ross commands you to think like Mr. Brimley. If you suspect your lessee is not paying proper royalties, do not wait to investigate. Even if you don’t suspect anything is amiss, investigate anyway or you will lose your right to sue. The Texas Supreme Court has reaffirmed the heavy burden imposed on a royalty owner to discover he is being underpaid by his lessee.

The Suit

Mr. Ross didn’t take Mr. Brimley’s advice, perhaps because he wasn’t working for the Mob.  He was dealing with a major oil and gas producer. Mr. Ross owned royalty interests in wells operated by Shell. The lease royalty was 1/8th of the amount realized. The state had a 50% royalty interest and was paid independently of the plaintiffs. For some unexplained reason, Shell paid what the court referred to as an “arbitrary price”, and Shell’s the best explanation at trial was that it “made a mistake”.

Mr. Ross was a lawyer who did oil and gas work. The suit was for fraudulent concealment, accusing Shell of withholding sufficient information for him to determine that they were being paid less than they should have been.

The Rationale

The “discovery rule” can stop the running of limitations on a fraudulent concealment claim. The court reiterated the test for the rule to apply in Texas litigation: The injury must be “inherently undiscoverable and objectively verifiable.” The test is administered on a “categorical basis”. There are no exceptions!

The court identified several sources of “readily accessible and publically available information” that could have lead the royalty owner, if he had used “reasonable diligence” to discover he had been underpaid.

Among those sources was the El Paso Permian Basin Index which, according to the court, would have revealed that the royalties being paid were too low. Another was the records of the Texas General Land Office, which did not reveal the price Shell paid to the state on the same land, but “would have revealed that Shell was underpaying” the Rosses. The opinion also suggests that Mr. Ross could have “ask[ed] the companies Shell sold the gas to the price they paid …”. The court did not handicap the likelihood of the success of such a request.

A Few Questions

• If Shell merely “made a mistake”, why didn’t the company go ahead and pay what it admitted it owed? (Granted, this one is more ethical than legal)

• Should the “inherently undiscoverable/objectively verifiable” test be tempered by, say, a requirement that the royalty owner have some reason to believe he is being underpaid in the first place? Must a royalty owner assume that everybody is out to underpay him? The court says “yes”. Constant vigilance is the standard. Generalized mistrust is the word of the day.  Think like Mr. Brimley, the Mob enforcer.

• How many royalty owners are sophisticated enough to look at sources like those mentioned by the court? I would say, not very many. How much success would a small royalty owner have when she asks the pipeline how much the large producer was paid on one lease? Not much, I would say.