Co-author Chance Decker

The Texas Supreme Court recently heard oral argument in three intriguing oil and gas cases.  Here’s what you need to know about two of them (We’ll address the third case soon).

Adams v. Murphy Exploration & Production Co. USA

Did lessee Murphy comply with an offset-well clause that doesn’t state where the offset-well must be drilled?  When a well was drilled on an adjacent tract, Murphy drilled its offset-well more than 2,000 feet from the triggering well. Continue Reading Opinions to Expect From the Texas Supreme Court

win loseYou are negotiating to take a big oil and gas lease. The run sheets show you are dealing with an executive right owner on behalf of himself and his NPRI owner.  His proposed terms are odd: a lower-than-market royalty and a higher-than-market bonus. After reflecting, you get it: The terms aren’t odd; they are just better for him than the NPRI owner. Is he cheating his NPRI owner? If you suspect he is, must you come to the aid of the soon-to-be-shortchanged NPRI owner or else get sued along with the larcenous executive?

Don’t worry. Bradshaw v. KCM leaves virtually no chance that a lessee will be derivatively liable to an NPRI owner for an executive’s wrongdoing. We discussed the NPRI owner’s claims against the executive last week. The NPRI owner also sued Range Resources, the lessee who took the lease from the executive.

Bradshaw’s claim against Range was that KCM’s breach of its duty should be imputed to Range under civil conspiracy and aiding and abetting theories. Not so, said the court. Range and KCM were not affiliated with one another except as adverse parties in an arms-length transaction (to-wit, the oil and gas lease). There was no claim that Range owed an independent fiduciary duty to Ms. Bradshaw. This is obvious because the lessee’s interests are inherently adverse to both the executive and the NPRI.

There was no evidence that Range was complicit in KCM’s alleged underlying tort. In negotiations between the two, Range sought to extract the best deal it could on the most favorable terms. The mere fact that Range knew the estate was burdened with Bradshaw’s NPRI was insufficient to impute KCM’s liability, if any, to Range.

The court observed that if it were to validate Bradshaw’s theory of liability it would be difficult to conceive of a context in which a lessee would not owe a derivative fiduciary duty to the other side of the bargaining table.

Even if there were an imbalance in the lease terms that substantially favored Range, that would not be evidence that Range acted improperly. The court believed that in a broad sense almost any bargain for a commercial exchange might be considered benefiting one party at the expense of the other. (Ironically, the court cited a Wal-Mart case for this proposition.)

Simply put, said the court, a lessee is not be expected to consider an NPRI owner’s economic interests. That is the executive’s responsibility.

In the spirit of today’s musical interlude, the court has made negotiating easier on the lessee.

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.

With apologies to Click and Clack, from time to time I will post “puzzlers”, questions about title and similar issues that have no apparent answer.  Here is the first one: 

Joe Bob Joiner owns a non-participating royalty interest under a tract.  The amount of interest he owns is tied to the amount of royalty stated in any lease affecting the tract. (i.e. he retains “½ x 3/16 lessor’s royalty”).  Daisy Bradford, the owner of 100% of the minerals on the tract, believes it is her destiny to be the H. L. Hunt of the 21st century and decides to go into the oil business by developing the minerals herself.  Therefore there is no oil and gas lease on the tract.  She drills a well and, lo and behold,  it is a producer!  What interest does Joe Bob the NPRI owner have in production from the tract?