Oil and Gas Lawyer Blog

The Texas Supreme Court has recently refused to hear Friddle v. Fisher, 378 S.W.3d 475 (Tex.App.-Texarkana 2012). The court of appeals' opinion has an interesting discussion of the duties of a mineral owner to owners of non-participating royalty interests burdening the mineral estate and of the application of the discovery rule to claims that such duties were breached.

These are the facts of the case:  In 1949, M.L. Friddle conveyed 84.7 acres in Hopkins County to Barney Martin, reserving 1/4 of the royalty. The reserved royalty interest later came to be owned by M.L. Friddle's son Marvin.  In 1995, Barney Martin conveyed 1/4 of the royalty in the 84.7 acres to Mable Robinson, and 1/4 of the royalty to Helen Warde. The following day, Martin conveyed the land to Fred and Ruth Fisher.  Later, Marvin Friddle acquired from Mable Robinson and Helen Warde the royalty interests that were conveyed to them. So, at the time this controversy arose, the Fishers owned the land and minerals, subject to a NPRI owned by Marvin equal to 3/4 of the royalty.

In 1998, the Fishers signed an oil and gas lease on the 84.7 acres, reserving a 1/8 royalty. Valence Operating Company formed a pooled unit, the Ames-Antrim Gas Unit, and pooled the 84.7 acres into the unit. Valence drilled a well on the unit, but the well was not located on the 84.7 acres. Neither Valence nor the Fishers notified Marvin of the granting of the lease, the formation of the pooled unit, or the drilling of the well. Valence paid all of the royalty attributable to the 84.7 acres to the Fishers.

Marvin did not find out about the Ames-Antrim Gas Unit until 2008, shortly before he filed suit against the Fishers and Valence. In his suit, Marvin contended that the Fishers and Valence had a duty to notify him of the lease and the unit and give him the opportunity to ratify the lease and/or the unit so that he would share in unit production and get his 3/4 of the royalty on the portion of unit production allocated to the 84.7 acres. Marvin also claimed that the Fishers had a duty to hold his share of the royalty in trust for him until it could be paid to him.

Marvin's suit against Valence was severed into a separate suit. The trial court granted the Fishers' motion for summary judgment and ruled that Marvin should take nothing by his suit. Marvin appealed.

The court of appeals reversed and remanded the case for trial. The court held that the Fishers, as holders of the leasing rights in lands in which Marvin has a royalty, had a duty -- the court calls it a fiduciary duty -- to notify Marvin of the lease and to "hold the portion of the funds which would be payable to the holder of the NPRI as constructive trustees for the use and benefit of the holder of the NPRI." The court relied as precedent on Andretta v. West, 415 S.W.2d 638 (Tex. 1967).

The facts in Andretta are similar to Marvin's case. In Andretta, the Wests signed an oil and gas lease on lands in which Andretta had a royalty interest. Superior Oil Company held the Wests' lease and an adjacent lease. Superior drilled a well on the adjacent lease, and the Wests claimed that Superior had a duty to drill an offsetting well on their property. In a settlement of that claim, Superior agreed to pay the Wests a compensatory royalty, as if the Wests had a 1/8th royalty in production from the adjacent tract. When Andretta found out about this settlement, he sued the Wests claiming 1/4th of the compensatory royalty payments being made to the Wests. The Texas Supreme Court held that Andretta was entitled to his 1/4th of that compensatory royalty. It said that, if the Wests knew the name and whereabouts of the royalty owner, "it was their duty to notify him of the [settlement] and account to him for his share of the payment as received."

The court of appeals in Friddle v. Fisher also had to address the Fishers' claim that Friddle had waited too long to file his suit. Under Texas law, a claim like Friddle's - a suit for breach of a fiduciary duty -- must be brought within four years of the date when the plaintiff discovered or should have discovered the breach of fiduciary duty. The court of appeals held that there was conflicting evidence in the record as to when Friddle discovered or should, in the exercise of reasonable diligence, have discovered the facts that gave rise to his claim, and that a jury should be asked to determine when Friddle should have discovered his claim.

The Fishers' attorneys argued strenuously that the discovery rule - the rule that the four-year limitation period for bringing suit does not begin until Friddle discovered or should have discovered his claim - should not apply to his claim, based on three recent Texas Supreme Cout cases, HECI Exploration Co. v. Neel, 982 S.W.2d 881 (Tex. 1998), Shell Oil Co. v. Ross, 35 S.W.3d 924 (Tex. 2011), and BP America Production Co. v. Marshall, 342 S.W.3d 49 (Tex. 2011). In those cases, the Texas Supreme Court has held that the discovery rule does not apply to royalty owners' claims against their lessee for additional royalties, and that the royalty owners have a duty to look after their interests and investigate whether they should be entitled to royalty payments. The court of appeals distinguished those cases on the ground that an oil and gas lessee does not owe a "fiduciary" duty to its lessor, but only a duty to act in good faith and as a prudent operator. A person owed a fiduciary duty is relieved of the obligation to diligently inquire into the fiduciary's conduct. He is entitled to assume that the fiduciary is looking after his interest until facts to the contrary are brought to his attention. So Friddle was relieved of any duty to "diligently inquire" into the Fishers' conduct, and the discovery rule applies to determine when he is barred by limitations from pursuing his claim.

I have previously written critically about the Texas Supreme Court's opinions in Shell v. Ross and BP v. Marshall. I believe that the court has placed an unreasonable burden on royalty owners to "diligently inquire" into their lessee's conduct to discover errors or misdeeds. The court is being asked to revisit this issue in another case now pending on petition for review, Hooks v. Samson Lone Star, L.P., on appeal from the First District Court of Appeals in Houston.

Many properties in Texas are burdened by non-participating royalty interests. In the early days of the oil business it was common for landowners to buy and sell NPRI's as a way to speculate on possible future oil and gas development. In some tracts there are dozens or even hundreds of royalty owners. The standard industry practice when tracts subject to NPRI's are leased is for the lessee to seek out the NPRI owners and request that they sign ratifications of the lease. The lessee wants the ratifications because they give the lessee the right to pool the NPRI interests in accordance with the pooling clause in the lease. Most mineral owners who sign leases on lands burdened by NPRI's assume that their lessee will obtain those ratifications and properly account to the NPRI owners for their share of production. Even identifying and tracking down the NPRI owners is sometimes a large task, one that most mineral owners would not wish to assume. While Friddle v. Fisher does not impose that burden on the mineral owner, the case does impose some amount of obligation on the mineral owner to see that the NPRI owner is dealt with fairly.

It may be prudent for mineral owners whose interests are burdened by NPRI's to include provisions in their leases affirmatively obligating their lessee to seek out and account to the NPRI owners, and to provide that information to the lessor so that he can assure that his obligations are satisfied.

The Texas Supreme Court has agreed to hear arguments in a case that could have important implications for landowners and oil and gas exploration companies: Merriman v. XTO Energy, No. 11-0494. Merriman's attorneys are asking the Court to reverse the 10th Circuit Court of Appeals, at Waco, which they contend has consistently mis-interpreted the Supreme Court's rulings on the accommodation doctrine.

The "accommodation doctrine" is a court-made doctrine relating to the mineral owner's right to use the surface estate to drill for and produce minerals. The mineral estate is the "dominant estate," meaning that the owner of the mineral estate has the right to use so much of the surface estate as is reasonably necessary for exploration and development of the minerals, without compensation to the surface owner for such use. (This includes the right to use groundwater for oil and gas operations, even though the groundwater belongs to the owner of the surface estate.) The Supreme Court has held that, notwithstanding the mineral owner's right to use the surface, the mineral owner must under some circumstances "accommodate" the surface owner's existing use of his land. The doctrine requires a balancing of the interests of the surface and mineral owner. In 1993, the Supreme Court said: "if the mineral owner has reasonable alternative uses of the surface, one of which permits the surface owner to continue to use the surface in the manner intended (especially when there is only one reasonable manner in which the surface may be used) and one of which would preclude that use by the surface owner, the mineral owner must use the alternative that allows continued use of the surface by the surface owner." Tarrant County Water Control & Impr. Dist. No. 1 v. Haupt, Inc., 854 S.W.2d 909, 912 (Tex. 1993).

Homer Merriman, the plaintiff in this case, owns 40 acres in Limestone County. When he bought the land, the seller reserved the mineral estate and the land was then subject to an oil and gas lease. Merriman built his home on the land. Although he works full-time as a pharmacist, Merriman also runs cattle. He leases land in Limestone County for grazing, and once a year he uses his 40 acres to round up and work his cattle, with portable pens that are assembled for the operation and then taken down. The rest of the year he grazes cattle on the 40 acres, where he also lives.

In 2007, XTO Energy approached Merriman and told him it intended to drill a well on his tract. Merriman objected to the proposed well location, arguing that it would prevent him from using the 40 acres for his cattle working operations. XTO discussed with Merriman moving the location to the southewest corner of his tract, where Merriman said it would be acceptable, but XTO ultimately decided not to accommodate Merriman's request. Merriman then sued XTO seeking an injunction to prevent the drilling of the well at its chosen location. Despite the suit, XTO drilled the well. The trial court granted summary judgment for XTO, and the Waco Court of Appeals affirmed, holding that Merriman "has alternative uses of his land that are not impracticable or unreasonable. Merriman further has alternative methods of conducting his cattle operation that are not impracticable or unreasonable."

(The well XTO drilled on Mr. Merriman's tract, the Beachcomber Unit 2 - 11 Well, is a Cotton Valley well located on a 703-acre pooled unit. It was the 10th well drilled on the unit. There are now 18 wells on the unit, including a horizontal well, all producing from the Cotton Valley formation. The 2-11 Well has to date produced almost 1 billion cubic feet of gas.)

Merriman's lawyers argue that the Waco Court of Appeals has held Meriman to too-high a burden of proof. They say that Merriman didn't have to prove that he had no other possible uses of his land, but only that the mineral owner's proposed use would prevent him from continuing his current use of the property and that XTO had an alternative location that would allow his use to continue.

The Supreme Court last wrote about the accommodation doctrine in 1993. Since then, horizontal drilling has been developed and drilling has moved into more urbanized areas. Conflicts between surface and mineral owners' rights to use land have increased. Merriman's attorneys urged the court to take up his case both to straighten out this and prior opinions of the Waco Court of Appeals on the subject and to provide more certainty as to the meaning and application of the accommodation doctrine. It will be interesting to see if the Court decides to give Merriman another chance to prove his case, more than five years after he filed it.

In a prior post, I wrote about a new development at the Texas Railroad Commission: granting permits for "allocation wells" - horizontal wells drilled across lease lines without pooling the leases. Since I wrote that post, our firm was retained to represent the parties protesting EOG Resources' application for a permit for an allocation well. A hearing on the application was held at the RRC on December 3. In addition to EOG and the protestants, Devon Energy appeared at the hearing supporting EOG, and the Texas General Land Office appeared opposing allocation wells on State-owned minerals. All parties have now submitted closing statements and responses, which can be viewed below:

Klotzman Closing Statement.pdf

EOG Closing Statement.pdf

Devon Closing Statement.pdf

GLO Closing Statement.pdf

Klotzman et al Response to Closing Statements.PDF

EOG Reply Closing Statement.pdf

Devon Reply Closing Statement.pdf

Our firm was also retained by the Texas Land and Mineral Owners' Association and several mineral owners to file a petition for rulemaking with the RRC, asking the RRC to address the issue of allocation wells by commencing a rulemaking proceeding. The RRC has not yet responded. The petition can be viewed here: Rulemaking Petition.pdf

Last week, a Texas district court ruled that Jimmy McAllen could keep his $20 million arbitration award against Forest Oil Corp. This fight goes back to 1992, when Forest Oil gave McAllen used drilling pipe to build animal enclosures on his exotic wildlife ranch, on which McAllen kept rhinoceroses. The pipe had scale that contained radioactive materials, and McAllen claimed that it made the animals ill. McAllen also contracted cancer, which he blamed on the pipe. McAllen also alleged that Forest secretly buried mercury, drilling waste and other radioactive material on his property. McAllen sued Forest in 2005. Forest claimed that McAllen was required to arbitrate the dispute under the terms of a prior settlement agreement between Forest and McAllen arising out of a suit for unpaid royalties. Forest's argument eventually made it to the Texas Supreme Court, which held that the prior settlement agreement was binding on McAllen and required him to arbitrate the dispute. Forest Oil Corp. v. McAllen, 268 S.W.3d 51 (Tex. 2008).

The case then went to an arbitration panel consisting of Houston attorney Daryl Bristow and South Texas attorneys Clayton J. Hoover and Donato D. Ramos. On February 29, 2012, the panel issued a split decision, 2-1, awarding McAllen $21.9 million plus $5 million in attorneys' fees and additional injunctive relief requiring Forest to post a $10 million bond for the life of the lease to assure cleanup of any pollution found on the ranch. In a 40-page dissent, Daryl Bristow said that the panel's award "turn[ed] the law on its ear" and "fabricate[s] a damages number without any principled foundation in the record."

Forest then filed suit to overturn the award. On September 19, Judge Jeff Shadwick, of the 55th District Court in Harris County, denied Forest's motion to overturn the award. The court's order said that "the panel reached its conclusions based on little to no admissible evidence," but that this "is one of the unfortunate hazards of arbitration." "The court is not at liberty to substitute its judgment for that of the arbitrators merely because it would have reached a different decision." Judge Shadwick did overturn the arbitration panel's requirement that Forest post a bond for future cleanup, saying that the panel had no jurisdiction to issue such relief.

Forest is sure to appeal the trial court's decision. It will be in the uncomfortable position of challenging an arbitration award after it fought all the way to the Supreme Court to force the case into arbitration. And so Jimmy McAllen's fight will likely continue for some time to come.

The 5th Circuit affirmed a judgment today against Chesapeake Exploration for $19,951,004 in favor of Peak Energy Corporation, for breach of a contract to purchase oil and gas leases in the Haynesville Shale area of Harrison County, Texas. Coe v. Chesapeake Exploration, No. 11-41003.  The Court's summary of the case:

In July 2008 Chesapeake Exploration LLC entered into an agreement to purchase deep rights held by Peak Energy Corporation in certain oil and gas leases in the Haynesville Shale formation, for the hefty sum of $15,000 per acre. When the price of natural gas plummeted several months later, Chesapeake refused to honor its commitment. In response to the complaint filed by Peak it contended that the parties' agreement was unenforceable under the Texas statute of frauds, fatally indefinite, and that the plaintiffs had failed to tender performance. The district court disagreed, rendering judgment in favor of Peak and its principals and awarding them damages in the amount of $19,951,004, prejudgment and post-judgment interest, and attorneys' fees and costs. Finding no error, we affirm.

In 2008, gas prices were high and the boom was on in the Haynesville Shale. Chesapeake was buying all of the acreage it could find. Its brokers identified leases covering 5,405 acres in Harrison County, Texas owned by Peak Energy, and on July 2, Chesapeake sent Peak a letter offering to buy all rights in its leases below the base of the Cotton Valley formation for $15,000 per net acre, with Peak delivering a 75% net revenue interest and reserving an overriding royalty on any excess over 75%. A map generated by Chesapeake was attached to the letter agreement showing the tracts Chesapeake had identified in which Peak had leases. The letter said that it was a "valid and binding agreement," and that the closing would occur on August 31. Peak signed and returned the letter.

The parties worked to assemble the list of leases and other closing documents. But in the meantime, the stock market and the gas market plunged precipitously. In October, there had still been no closing of the deal, and Chesapeake informed Peak that it would not be completing the transaction. Peak sued. At trial, Peak said it was able to deliver only 1,645.9 acres of leases with a minimum 75% net revenue interest; it showed that the market value of the deep rights in those leases was $3,000 per acre; and it sought damages equal to $12,000 per acre, based on the difference between the contract price of $15,000 per acre and the market price on the date of the breach, $3,000 per acre. The judge agreed with Peak and awarded the damages sought, plus interest and attorneys fees of more than $435,000.

Chesapeake claimed that the contract was not enforceable because the map attached to the letter agreement did not provide an adequate description of the property. The 5th Circuit disagreed. It said that the map provided an adequate nucleus of description to allow a knowledgeable person to identify the leases with reasonable certainty from public records.

Chesapeake claimed that the contract was not enforceable because it did not include "essential terms." The court said that the letter agreement did provide all of the essential terms - the property to be conveyed, the price, the closing and delivery date, and the purchaser's interest in the property. The court said that the lack of a final lease schedule, and the fact that the parties did not agree on warranty of title, non-compete provisions, and options to purchase additional acreage, were not essential terms fatal to a binding agreement. "Although the parties must agree to all material terms, they may choose to leave non-essential terms open for later negotiatin without rendering the agreement unenforceable."

Finally, Chesapeake claimed that the agreement was not enforceable because Peak could not perform its obligations under the agreement. Peak conceded that it could only deliver 1,645 acres of leases meeting the agreement's specifications. The court said that Chesapeake was bound by the agreement to purchase the leases that Peak could deliver.

It appears to me that Chesapeake did not have any viable defenses to the claim, and that the court clearly reached the correct result. More importantly, the case sheds light on Chesapeake's attitude about its contractual commitments. Others contemplating deals with Chesapeake, especially on buying oil and gas leases, may be reluctant to deal with the company if this case is representative of its willingness to go back on its deals.

The Texas Supreme Court issued two important condemnation cases on the last day of its term, both reversing judgments after jury trials in condemnation suits.

In City of Austin v. Harry M. Whittington, the court resolved the Whittington's ten-year battle with the City over condemnation of a city block adjacent to the City's convention center. The jury found that the City's determination that its condemnation of the property was for a "public use" was fraudulent, in bad faith, and arbitrary and capricious. The Court said that "the Whittingtons do not dispute the underlying facts on these issues; rather, they dispute the legal effect of those facts (e.g., whether those facts amount to fraud, bad faith, or arbitrariness and capriciousness). Because these issues are legal questions, we review them de novo." In other words, the Court held that it was not bound to support the jury's verdict, but could look at the evidence and decide for itself. It decided that the evidence did not show that the City was guilty of fraud, bad faith, or arbitrary or capricious behavior. The City condemned the block for a private developer to build a parking garage for the convention center. Two Justices dissented.  (My firm represented the Whittingtons in this case.)

In Enbridge Pipelines (East Texas) L.P. v. Avinger Timber, the jury awarded Avinger $20,955,000 for Enbridge's condemnation of a site owned by Avinger on which a gas processing plant was located. The site was subject to a long-term lease that expired, and when the parties were unable to agree on terms for extension of the lease, Enbridge sued to condemn the property. The issue on appeal was whether the testimony of the valuation experts for Enbridge and Avinger was admissible. The Court held that both experts' testimony was inadmissible and remanded the case to the trial court for a new trial. The Court held that the landowner's appraiser violated the "value-to-the-taker" rule--meaning that he impermissibly took into account the unique value of the land to the condemning gas processing company (as opposed to considering the value to a hypothetical willing buyer, as the law requires). In particular, the appraiser had taken into account the cost to the company of removing the plant on the land if it were sold; the Court held that the appraiser should not have factored in those costs because that was a cost unique to the condemnor and not one that impacted the value of the land to a potential buyer.

But on the other hand, the Court ruled that the condemnor's appraiser was wrong to value the property as rural, unimproved land, ignoring the pipeline infrastructure that had built up over the years and the current suitability of the property for use as a gas-processing facility.

Add these to the list of cases in which the Court has reversed judgments in favor of landowners. See Samson Lone Star v. Hooks, Shell v. Ross, BP v. Marshall, Exxon v. Emerald.

This week, the Texas Supreme Court denied Denbury Green Pipeline's motion for rehearing in Texas Rice Land Partners v. Denbury, leaving essentially untouched its conclusion that pipelines must prove that they serve the public in order to exercise eminent domain power.

I wrote about this case a couple of weeks ago. See my prior discussion here. Pipeline companies had deluged the Court with briefs after its initial opinion, claiming that the Court's decision will halt pipeline construction across the state.

While denying Denbury's motion for rehearing, the Court did issue a revised opinion that made some changes to its language. The Court's opinion adds language responding to some of the arguments of the friend-of-the-court briefs filed by other pipeline companies; and the revised opinion changes the holding as follows:

We accordingly hold that for a person intending to build a CO2 pipeline to qualify as a common carrier under Section 111.002(6), a reasonable probability must exist that the pipeline will at some point after construction serve the public by transporting gas for one or more customers who will either retain ownership of their gas or sell it to parties other than the carrier.

The Court also added a footnote to its holding: "Our decision today is limited to persons seeking common-carrier pipeline status under Section 111.002(6) [of the Natural Resources Code]. We express no opinion on pipelines where common-carrier status is at issue under other provisions of the Natural Resources Code or elsewhere." (Section 111.002(6) relates only to pipelines that transport carbon dioxide. Other provisions of the Code cover pipelines that carry natural gas and hydrocarbons.)

James Mann, an Austin attorney and lobbyist for the pipeline industry, was quoted in the Houston Chronicle as commenting that "It's unclear to us just how bad this opinion is. If it only affects CO2 pipelines, it can be survived. If the same holdings are applied to all other types of pipelines, it is disaster for the oil and gas industry." Kent Sullivan, a lawyer with Sutherland Asbill & Brennan in Houston, said that the opinion represents "a substantial shift in power or potential leverage" for landowners. Sullivan predicted that the issue is likely to be a topic in the 2013 legislative session.

The Texas Supreme Court issued its opinion today in Edwards Aquifer Authority v. Day, more than a year after it was argued and some thirteen years after the controversy began. It has been eagerly awaited as the court's ruling on whether a landowner has a "vested" right in groundwater under his/her land. The Court held that groundwater, like oil and gas, is "an exclusive and private property right ... inhering in virtue of [the landowner's] proprietorship of the land, and of which he may not be deprived without a taking of private property." The case is being heralded by property rights advocates as a victory for private property rights. The court's decision, in an opinion by Justice Nathan Hecht, was unanimous.

The opinion is certainly not surprising. It would have been a surprise to most people to learn that they do not have ownership rights in groundwater under their property. But I question whether it is such a victory for property owners and whether it will materially change the current regulatory scheme for groundwater in Texas.

Justice Hecht's opinion, 49 pages, includes a good summary of the history of groundwater regulation and litigation in Texas over the last 100 years. Remarkably, in all that time the Court had never ruled on the question of whether landowners have a property right in groundwater. The court held that the same rules should apply to groundwater as apply to oil and gas - in both, the landowner has an ownership right in the substance under his/her land, subject to being divested of that ownership by drainage from wells on adjacent lands, and subject to reasonable regulation by the state.

In EAA v. Day, two farmers owned 350 acres south of San Antonio. They applied to the Edwards Aquifer Authority for a permit for their existing water well on the property. Under the rules of the EAA, their right to use water from the well depended on what use they made of the water during the historic period from June 1, 1972 to Mary 31, 1993. The farmers applied for a permit to pump up to 700 acre-feet per year, for irrigation. The EAA granted a permit for only 14 acres, finding that their proof of historic use was not adequate. The farmers then sued, alleging that denial of their permit for 700 acre-feet constituted a taking of their property without compensation. After holding that the farmers did have a "property right" in their groundwater of which they could not be deprived without compensation, the Court remanded the case to the trial court for additional evidence on whether the EAA's regulations did in fact constitute a taking of property for which compensation is due.

This is where the case gets interesting. The court discusses how the trial court, when it gets the case back, should decide whether the farmers are entitled to compensation. Relying on a US Supreme Court case, Penn Central Transp. Co. v. New York City, the court adopted a test of "reasonableness": the trial court must consider "the economic impact of the regulation on the claimant and, particularly, the extent to which the regulation has interfered with distinct investment-backed expectations"; and the "'character of the government action' -- ... whether it amounts to a physical invasion or instead merely affects property interests through 'some public program adjusting the benefits and burdens of economic life to promote the common good.'" Considering these factors, the court must decide whether the economic impact of the regulation on the farmers, considering the promotion of the common good resulting from the regulation of groundwater imposed by the EAA, rises to the level of a "taking" of private property for public use. This in my opinion does not give the trial court much to go on. It is a pretty subjective test and will depend on particular facts. The Supreme Court remanded the case to the trial court to further develop those facts.

So what does this mean for Texas landowners and groundwater districts? Perhaps more litigation. Landowners unhappy with decisions made by their local water district may sue claiming that the district has "taken" their water rights. But, as can be seen by the Day case, such a battle is not to be taken on lightly -- in fact, Mr. Day died before the decision was issued -- and will be expensive. And there is the possibility that an unsuccessful claimant would have to reimburse the water district's legal fees. Most water districts have very limited budgets and so will be reluctant to fight landowners' inverse condemnation suits. As a result, they may be more cautious in how they draft and enforce their regulations.

All in all, the case is an important, but not surprising, milestone in the continuing development of groundwater rights law in Texas.

The Texas Supreme Court has once again reversed a jury verdict in favor of a royalty owner, holding that their claim is barred by limitations. The Court today issued its opinion in Shell Oil Company v Ross, reversing the judgments of the courts below in favor of Ross for $72,000 in unpaid royalties.

I wrote about this case back in January, see my previous post here.

Ross' lease required that royalties on gas be based on the "amount realized" by the lessee. But from 1988 to 1994 Shell paid royalties based on a weighted-average price instead of the price it received for the gas. Then from 1994 to 1997, Shell paid royalties based on an internally generated "transfer price," which Shell admitted it could not explain. In both cases, Shell admitted that it had not paid royalties as required by the lease. Its sole defense was that the royalty owner had failed to bring his claim within the four-year statute of limiations.

The jury found that Shell fraudulently concealed its failure to pay royalty, and that Ross, exercising reasonable diligence, could not have discovered the royalty underpayment until 2002. The court of appeals affirmed, holding that there was sufficient evidence in the record to support the jury's findings.

The Supreme Court, in an opinion by Justice Lehrman, held that, "as a matter of law," the evidence showed that Ross should have discovered the royalty underpayments when they were made from information that was "readily accessible and publicly available."

Ross argued that he reasonably relied on the gas price Shell put in his royalty statements, because a Texas statute requires Shell to report on the check stub the price it received for the sale of the gas. The Court disagreed. It held that a royalty owner in effect must assume that the gas price on the royalty check stub is not accurate. "Reasonable diligence requires that owners of property interests make themselves aware of relevant information available in the public record."

What public information should Ross have looked at? First, said the Court, Ross should have asked Shell what price it was receiving for the gas. Or, Ross could have asked the companies to whom Shell sold the gas what price they paid. Or, Ross could have compared the price to a publicly available index price, which "would have informed the Rosses that Shell was underpaying royalty." Ross could have researched records at the Texas General Land Office to see what price the State was receiving for its royalty interest in the same wells.

The Court's opinion confirms the statements made by Justice Sharp of the Houston First District Court of Appeals in Samson Lone Star v. Hooks, decided earlier this year:

I reluctantly concur, based on the Texas Supreme Court's holding in BP America Production Co. v. Marshall, 342 S.W.3d 59 (Tex. 2011). In that case, the Texas Supreme Court makes clear that no lies on the part of a lessee, however self-serving and egregious, are sufficient to toll limitations, as long as it is technically possible for the lessor to have discovered the lie by resort to the Railroad Commission records. This burden the Court imposes upon lessors is severe. It is now a lessor's duty to presume that any statement made by its lessee is false and to ransack the esoteric and oft-changing records at the Railroad Commission to discover the truth or falsity of its lessee's statements. If, as is often the case, these records are technical in nature and require expert review to ferret out the truth, it is the lessor's job to hire experts out of its own pocket to perform such a review. If a lessor fails to take these steps, then it will have failed in exercising reasonable diligence to protect its mineral interests and, if the lessee's fraud is successful for longer than the limitations period, the lessor's claims will be barred by limitations.

The lesson: mineral owners should reserve the right to audit their royalty payments, and they should exercise that right at least every 3 to 4 years, to be sure that their royalties are being paid in accordance with their lease.

Another interesting case is pending before the Texas Supreme Court, this one involving condemnation of a pipeline easement. The San Antonio Court of Appeals, in LaSalle Pipeline v. Donnell Lands, affirmed a jury verdict awarding $650,000 to the landowner. The Supreme Court has asked for briefs on the merits but has not yet agreed to hear the case.

The Donnell family own an 8,000-acre ranch in McMullen County. LaSalle Pipeline sued to condemn an easement for a sixteen-inch gas pipeline across the ranch, for a length of 4.4 miles. In Texas, a condemnation case originally goes to three "commissioners" - citizens in the county appointed by the court to determine the amount to be awarded the landowner for the pipeline easement. The commissioners awarded the Donnells $226,000 for the easement - about $160 per rod, or $9.73 per foot. (A rod is 16.5 feet.) The Donnells appealed to the district court in McMullen County, where there was a trial de novo, meaning that the commissioners' award was not considered and the jury was asked to determine the amount of the award based on evidence at the trial.

There are three elements of damages in a pipeline condemnation case: the damage to the land within the permanent easement; the temporary damage caused to the land by the additional workspace needed to lay the pipeline; and the diminution in value of the remaining property caused by the existence of the pipeline. These damages are estimated by qualified real estate appraisers, who testify as experts at the trial.

The Donnells' real estate expert testified that the land within the easements was damaged by $34,500; the temporary workspace easement caused damage of $19,200; and the damage to the Donnells' remaining land caused by the easement was $820,000. He said that the portion of Donnell's property which was affected by the pipeline was 4,100 acres, and that the value of that 4,100 acres was decreased about 10% by having a sixteen-inch pipeline across it. LaSalle's expert testified that the pipeline had no effect on the value of the Donnells' property.

The jury awarded the Donnells $658,533 (about $468 per rod). The San Antonio Court of Appeals reduced the trial court's award for the temporary construction easement by $12,800, but otherwise affirmed the trial court's judgment.

In its appeal to the San Antonio court, LaSalle argued that the Donnells' appraiser's testimony could not support the jury's award for damage to the remainder of the Donnells' land. LaSalle argued that the evidence was "legally and factually insufficient" to support the verdict. In Texas, our intermediate appellate courts can overturn a jury verdict if it finds that the evidence is "factually insufficient" to support the jury's verdict. The court may overturn a jury's verdict "if the evidence is so weak or if the finding is so against the great weight and preponderance of the evidence that it is clearly wrong and unjust." The San Antonio court found that the Donnells' evidence was factually sufficient to support the verdict.

Our Texas Supreme Court has authority to overturn a jury verdict only if the evidence is "legally insufficient" to support it. In other words, the Court may not "weigh" the evidence and may not overturn a verdict on factual insufficiency grounds. The Court may reverse a verdict only if there is a complete absence of evidence of a vital fact or the evidence offered to prove a vital fact is "no more than a mere scintilla," or if the evidence establishes conclusively the opposite of the vital fact. All of this may sound a little bit arcane, but in the world of lawyers this distinction is important. In LaSalle's appeal to the Supreme Court, it has a harder burden to prove that the jury's award should be overturned. LaSalle must show that there was "no" competent evidence to support the verdict.

This is an important case to pipeline companies, who are busily condemning pipelines in the Eagle Ford Shale play. As LaSalle's brief says, "under the Fourth Court of Appeals' reasoning, there can be no certainty or predictability in the budgeting for land costs associated with such projects, because under the Court of Appeals' opinion landowners may impermissibly reap substantial remainder damages based solely upon speculation and conjecture. The appellate decision in this case is being cited by landowners in condemnation actions pending throughout South Texas and the Eagle Ford Shale area for the proposition that substantial remainder damages are due in every pipeline condemnation case."

If the Supreme Court elects to take this case, it will be interesting to see if it decides once again to overturn a jury verdict in favor of a landowner.

Mineral owners have lost another substantial verdict against an oil company based on their failure to bring the claim within four years. In Samson Lone Star v. Hooks, No. 01-09-00328-CV, the Houston First District Court of Appeals reversed a verdict and judgment against Samson for $21 million, holding that the claim was barred by the four-year statute of limitations as a matter of law -- even though the jury had found that the Hooks should not have discovered Samson's fraudulent conduct until April 2007, less than four years prior to their suit.

The case is reminiscent of a similar case, Exxon v. Emerald, decided by the Texas Supreme Court in 2009, in which the Supreme Court reversed an $18 million verdict against Exxon, again on the basis that the mineral owners' claims were barred by limitations -- despite an express finding by the jury that the plaintiffs had filed their claim within four years after they discovered or should have discovered Exxon's fraudulent conduct. (Pat Lochridge, the lawyer who represented Exxon in the trial court in Exxon v. Emerald, represented the plaintiffs in Samson v. Hooks. You win some, you lose some.)

The Supreme Court did it again in BP v. Marshall, decided earlier this year. Again the Court overruled a jury verdict in favor of royalty owners, holding that their claim was barred by limitations as a matter of law.

One justice wrote a separate opinion in Samson v. Hooks, reluctantly concurring with the majority on the limitations issue and agreeing that the court was bound by the Supreme Court precedent in BP v. Marshall, but urging the Supreme Court to revisit its prior rulings. In my view, it is an eloquent argument against the prior rulings of the Supreme Court. Here is the relevant portion of Justice Jim Sharp's concurring opinion:

It is undisputed that Samson drilled a directional well bottomed within the "buffer zone" established in the Hooks' Jefferson County Lease (the "Lease") and failed to elect between the three alternatives outlined in the Lease, thus exposing itself to liability for breach of contract. If the Lease had allowed pooling, Samson could have solved the problem by pooling the lands covered by the Lease with the adjacent lands. The Lease, however, did not allow pooling.

Samson's solution to this problem was to begin misrepresenting various "facts" to escape the consequences of its actions. Its landman, Lanoue, filed papers with the Railroad Commission falsely certifying that Samson had pooling authority from the Hooks. He later filed paperwork in the county's real property records falsely indicating that the Hooks had already agreed to pool. Lanoue then sent a letter to the Hooks asking them to agree to pool the westernmost 50 acres of the Hooks' acreage in the Lease into the BSM 1 Unit. When Charles Hooks called Lanoue and asked for more information about the well's location, Lanoue represented to Hooks that the well was located approximately 1500 feet from the lease line, a location outside the buffer zone. When Charles Hooks asked for a plat, Lanoue faxed him one that represented a bottom-hole location that was +/- 1400 feet from the lease line, the accuracy of which he, Lanoue, had certified with no reference to an actual bottom-hole location, although it was ascertainable from a prior directional survey. Instead, when asked the origin of those measurements, he answered: "I got them from myself." On this basis the Hooks agreed to the formation of the unit.

Thus it is clear that Samson, through its representative, took action to cover up its own error by both oral and written misrepresentations to its lessor, born of "assuming" and "hoping." It is further clear that the Hooks, after asking for and receiving verification of Lanoue's oral representation in the form of a plat, believed its lessee's representations and made no attempt to go beyond them to discover the truth or falsity thereof. On these facts, the majority has found that the discovery rule does not apply to the Hooks' fraud, fraudulent inducement, and statutory fraud claims and that they are barred by limitations as a matter of law.

I reluctantly concur, based on the Texas Supreme Court's holding in BP America Production Co. v. Marshall, 342 S.W.3d 59 (Tex. 2011). In that case, the Texas Supreme Court makes clear that no lies on the part of a lessee, however self-serving and egregious, are sufficient to toll limitations, as long as it is technically possible for the lessor to have discovered the lie by resort to the Railroad Commission records. This burden the Court imposes upon lessors is severe. It is now a lessor's duty to presume that any statement made by its lessee is false and to ransack the esoteric and oft-changing records at the Railroad Commission to discover the truth or falsity of its lessee's statements. If, as is often the case, these records are technical in nature and require expert review to ferret out the truth, it is the lessor's job to hire experts out of its own pocket to perform such a review. If a lessor fails to take these steps, then it will have failed in exercising reasonable diligence to protect its mineral interests and, if the lessee's fraud is successful for longer than the limitations period, the lessor's claims will be barred by limitations.

Such is the case here. Had the Hooks presumed that Samson's oral representations, followed by written representations, about the bottom-hole location of the well were false, and had they hired an expert to resort to Railroad Commission records to trace the various filings (some of which were also false), that expert could have hit upon the directional survey and, by virtue of his expertise, interpreted it to prove the falsity of the representations. Instead they merely relied on the oral and written representations of their lessee, without undergoing what doubtless seemed to them the useless expense of hiring an expert to rake through the Railroad Commission records with an eye towards exposing a potential falsehood.

I believe the Texas Supreme Court has placed an unnecessary and very heavy burden on lessors by its ruling in BP America, one that will result either in much money being spent unnecessarily on prophylactic forensic review of Railroad Commission records or in many viable claims being lost to limitations. As we are, however, bound to follow the Court's rulings, I reluctantly concur in that part of the opinion that finds the Hooks' fraud, fraudulent inducement, and statutory fraud claims barred by limitations as a matter of law.

The case will surely be appealed, so we shall see if the Supreme Court revisits the issue.

The Eighth Court of Appeals in El Paso has issued its opinion in State of Texas v. Cemex Construction Materials South, LLC. The court reversed a summary judgment for Cemex and granted the State's summary judgment, returning the case to the trial court to assess damages. The State is seeking damages of $558 million.

Cemex is the world's leading supplier of ready-mix concrete, and one of the world's largest producers of White Portland Cement. Cemex is based in Monterrey, Mexico, and has operations across North and South America, Europe, Africa, the Middle East and Asia. It has annual sales of more than $14 billion.

Cemex operates a quarry for sand, gravel and caliche in El Paso County. According to the State's petition, Cemex and its predecessors have mined about 100 million tons of materials from the quarry since 1940. Cemex bought the quarry from the British group RMC in 2005.

The State claims to own the rights to the materials mined from the quarry because the sand, gravel and caliche are "minerals" reserved by the State when the lands were originally granted in 1900, 1906 and 1912. The El Paso court held that the lands were classified as "mineral" at the time of the original grants and are therefore "mineral-classified lands," and that the sand, gravel and caliche consitute "minerals" and are therefore owned by the State as a matter of law. (See my previous article on mineral-classified lands here.)

The Court of Appeals relied on the opinion of the Texas Supreme Court in Schwarz v. State, 703 S.W.2d 187 (Tex. 1986), which held that the State owns all coal and lignite under mineral-classified lands in Texas. Schwarz is notable because it applies a different rule in determining what substances are "minerals" for purposes of minerals reserved to the State than the rule it has adopted for construction of instruments reserving "minerals" between private parties. Some substances are not considered "minerals" in a private transaction if the removal of those substances would destroy the surface estate. But the Court in Schwarz rejected this rule for classification of "minerals" reserved to the State. So, according to the El Paso court's opinion, the State owns all sand, gravel and caliche in mineral-classified lands even if mining of those substances would destroy the surface estate.

The El Paso court's opinion in Cemex does not discuss what test should be applied under Schwarz to determine whether a substance is a "mineral" and therefore owned by the State. For conveyances and reservations between private parties after June 8, 1983, whether a substance is a "mineral" is determined by the "ordinary-and-natural-meaning" test. Under this test, "other minerals" includes "all substances within the ordinary and natural meaning of that word" regardless of how they are extracted. Moser v. U.S. Steel Corp., 676 S.W.2d 99 (Tex. 1984). Limestone, building stone, sand, gravel and caliche have been held not  to be "other minerals" under this test. The court in Schwarz appears to be applying the ordinary-and-natural-meaning test in classifying lignite as a "mineral": "It is clear that the sovereign in Texas has always claimed all of the substances commonly classified as 'minerals' and only gives away those substances by an express release or conveyance." 703 S.W.2d at 191 (emphasis added). Clearly, the El Paso court did not apply this test to the State's mineral reservation:

[B]ecause the State did not unequivocally grant to the original purchasers in clear and explicit terms the dirt, caliche, sand, gravel, limestone and other minerals and materials to which Cemex now claims ownership, those items were withheld from the State's conveyances of the ... lands and any ambiguity or obscurity in the terms of the statute, such as the terms "the minerals," "stones valuable for ornamental or building purposes," and "other valuable building material," must be interpreted in favor of the State.

The El Paso court appears to be holding that any substance of economic value that can be removed from the land is a "mineral" for purposes of the State's title.

Cemex will undoubtedly be asking the Texas Supreme Court to review the case.

Earlier this year, the San Antonio Court of Appeals issued an opinion in a case contesting the will of Belton Kleberg (B.K.) Johnson, greatgrandson of the founder of the King Ranch. Johnson died in 2001 at the age of 71. In the 1950's, Johnson was passed over to head the management of the 825,000-acre King Ranch lands, and he sold his interest in the Ranch in 1976, but kept his royalty interests.

Johnson's life and the will contest opinion give a rare glimpse into the world of the rich and powerful in South Texas. Johnson was educated at Deerfield Academy, Cornell and Stanford. He served on the board of directors of AT&T, Tenneco, Campbell Soup, the Southwest Foundation for Biomedical Research, and several Texas banks. He was the owner of Chaparrosa south of San Antonio, where he lived and raised his family and raised registered Santa Gertrudis cattle. He owned the Hyatt Regency Hotel on the San Antonio Riverwalk, and he restored the Fairmount Hotel in San Antonio.

Johnson was married three times. He and his first wife, Patsy, had three children: Ceci, Sarah and Kley. Kley died in a car accident in 1991, survived by his wife and two children. Sarah married Steven Pitt and they have three children. Ceci married Mark McMurrey, and they have three children.

Johnson divorced Patsy in 1987, and in 1991 he married Lynne, who died of cancer in 1994. In 1996, he married Laura, to whom he was married when he died in 2001.

At the time of his death, Johnson's latest will, written in 1999, left his estate to a trust. His wife Laura was the beneficiary of the trust for the remainder of her life. The trust gave Laura the right to name Johnson's children and grandchildren as beneficiaries of up to 1/2 of the trust property (a "power of appointment"), and the other half (or the entire trust estate if Laura did not exercise her power of appointment) would go to a foundation created by Johnson, the Belton Kleberg Johnson Foundation. So the 1999 will essentially left 1/2 of his estate to his foundation, and gave Laura control over whether his children and grandchildren would get any of the other half.

Johnson's daughters and grandchildren were not pleased with the estate plan created by Johnson's 1999 will, so they brought suit contesting the will, alleging that Laura had exercised "undue influence" over Johnson to get him to sign this will. The jury found that Laura had exercised undue influence. The Court of Appeals affirmed. The court also affirmed the trial court's award of $6.1 million in attorneys' fees to the lawyers for Johnson's children and grandchildren.

Additional appeals and fights will undoubtedly follow.

The Texas Supreme Court issued three opinions last week of interest to Texas land and mineral owners: one dealing with the duties of holders of executive rights, one limiting the condemnation powers of pipelines, and one addressing whether injection well operators can be held liable for trespass if the injected substances migrate onto adjacent lands.

Leslie v. Veteran's Land Board - The duty of the executive rights holder

The Supreme Court again considered what duty the holder of the right to lease ("executive right") minerals owned by another has to the non-executive mineral interest owner. The court significantly weakened its prior decision in In re: Bass, and increased the duties of the holder of the executive right. The right to lease is often separated from the mineral interest. For example, if I sell a tract to a developer, but want to keep part of the mineral interest, the developer may object, worried that I, as a mineral interest owner, might lease my interest and allow a company to drill wells on the property he intends to develop for a residential subdivision. A common solution to this problem is for me to retain a part of the mineral interest (or a part of the royalty interest) but convey to the developer the exclusive right to lease the minerals. The developer is then protected, because no mineral development can take place without his consent. Whenever the right to lease is separated from the mineral or royalty interest, the holder of the leasing right is called the holder of the "executive right," and the other mineral or royalty owner without any leasing right is called the owner of the "non-executive" interest.

In the Leslie case, a developer named Bluegreen purchased 4,100 acres of land in southwest Tarrant County, outside of Fort Worth, to develop a large residential subdivision, Mountain Lakes, of over 1700 lots. Bluegreen acquired some of the minerals in the 4,100 acres and all of the executive rights to the minerals. Bluegreen then imposed restrictive covenants on its development to govern what kinds of homes could be built, what uses of the property could be made, etc. One of those restrictive covenants prohibited "commercial oil drilling, oil development operations, oil refining, quarrying or mining operation." Later, development of the Barnett Shale formation in Tarrant County occurred, and companies sought to lease the 4,100 acres to drill Barnett wells, but found that the restrictive covenant prohibited development. Evidence in the case showed that "Mountain Lakes is sitting on $610 million worth of minerals that, in large part, cannot be reached from outside the subdivision." So the non-executive mineral owners sued, seeking to have the restrictive covenants declared void. Their theory was that, by imposing the restrictive covenant prohibiting mineral development, Bluegreen had breached its duty as the holder of the executive rights. The trial court declared the restrictive covenant void, but the Eastland Court of Appeals upheld it. The Supreme Court agreed with the trial court, holding that "Bluegreen breached its duty to [the non-executive mineral owners] by filing the restrictive covenants. The remedy, we think, should be the ... cancellation of the restrictive covenants."

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