Betty Lou Bradshaw’s parents owned 1773 acres in Hood County. In 1960, they sold the land and reserved 1/2 of the royalty on oil, gas and other minerals. Betty Lou inherited her parents’ royalty interest.
In 2005, Steadfast Financial (subsequently renamed KCM Financial) acquired the right to purchase the land. In 2006, KCM made a deal with Range Resources by which it simultaneously (1) exercised its right to purchase the land, (2) sold the land to Range, reserving all minerals, and (3) leased the mineral estate to Range. The lease provided for 1/8th royalty, and the bonus was $7,505 per acre.
Betty Lou sued KCM and Range. She alleged that they conspired to limit her royalty on production from the lease to 1/16 (1/2 of 1/8), whereas it should have been 1/8 (1/2 of 1/4), since the going rate for lease royalties in Hood County at the time was 1/4. She alleged that Steadfast had agreed to a lower royalty in order to receive an above-market bonus.
The trial court dismissed Betty Lou’s claims, holding that KCM and Range had not breached any obligation to Betty Lou.
The Supreme Court remanded Betty Lou’s case against KCM for trial, but it dismissed her case against Range.
It has long been known in Texas that the owner of minerals whose mineral estate is subject to a royalty interest owned by another has a duty of “utmost good faith” to the royalty owner. The Supreme Court held that Betty Lou had presented sufficient evidence that KCM had breached its duty to her to entitle her to a jury trial on the issue.
The Court said that the holder of the “executive right” – the right to grant oil and gas leases – has a duty “to acquire for the non-executive [the royalty owner] every benefit that he exacts for himself,” but that “the executive is not required to grant priority to the non-executive’s interest.” Evidence that the holder of the executive right is guilty of self-dealing “can be pivotal.” “Self-dealing has most commonly been observed in situations where the executive employs a legal contrivance to benefit himself, a close familial relation, or both.” “The controlling inquiry is whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.”
In Betty Lou’s case, “the allegation is that the executive [KCM] has misappropriated what would have been a shared benefit ( market-rate royalty interest) and converted it into a benefit reserved only unto itself (an enhanced bonus), with the intent to diminish the value of Bradshaw’s royalty interest. If proved, such conduct is the essence of self-dealing.”
As part of KCM’s agreements with Range, KCM promised “to honor and uphold any interest Betty Lou Bradshaw is determined to be entitled to in” the leased property. It is evident that Range knew that Steadfast was bargaining for a below-market royalty in order to get a higher bonus, and it was concerned that it might have some liability to Betty Lou. But the Supreme Court held that Range had no duty to protect Betty Lou’s interest. “Evidence that Range knew the [mineral] estate was burdened with Bradshaw’s non-participating royalty interest, may have known about tensions between Bradshaw’s and Steadfast’s interests, and agreed to a one-eighth royalty and an eight-figure bonus payment to Steadfast are simply insufficient to impute Steadfast’s liability, if any, to Range.” “[I]n negotiating with the executive, a lessee should not fear liability for doing nothing more than getting a good deal closed.”
After KCM granted its lease to Range, it transferred its reserved lease royalty to third parties. Betty Lou included those third parties in the suit and asked for a “constructive trust” on those royalty interests, on the theory that she should have received a 1/8 royalty, and since the lease provides for only 1/8 royalty, all of the royalty should go to her. A constructive trust is a remedy courts will grant where (1) there has been a breach of a special trust or fiduciary relationship or fraud, (2) the wrongdoer has been unjustly enriched, and (3) as a result the injured party has lost identifiable property that can be returned. The remedy is that the wrongdoer is found to be holding the property in “constructive trust” for the injured party.
The Court refused to accept Betty Lou’s constructive trust remedy. It said she had failed to show that she had lost “identifiable property” that could be returned to her. The Court’s logic was: Betty Lou owned an interest equal to 1/2 of the royalty. Her parents had sold the other 1/2 of the royalty when they sold the land. The royalty interest Steadfast had transferred to the other defendants was the royalty Betty Lou’s parents had sold, not part of the royalty she owned. “The royalty payments on which Bradshaw seeks a constructive trust emanate from [the mineral interest her parents had sold], which Steadfast retained when it conveyed [leased] the mineral rights to Range, and not from the one-half of royalty interest reserved by [Betty Lou’s parents] in the 1960 deeds.”
What if KCM had not transferred it reserved royalty interest to third parties, but still owns it? Would the Supreme Court say that Betty Lou could not claim that royalty interest? I think another way to analyze the case is that KCM traded its royalty interest to Range for an increased bonus, so, to make Betty Lou whole, she should receive the royalty reserved in the lease.
If Betty Lou wins her case before the jury, she can get a judgment against KCM but not against Range or the persons to whom KCM transferred its royalty interest. It is not clear to me what the measure of damages for Steadfast’s breach of duty should be. One way to approach the problem: suppose that a market bonus rate for the lease would be $3,000/acre. Steadfast got $7,505/acre. For 1773 acres, the part of the bonus above the market rate would be $7,996,375. That is the additional bonus Steadfast received for lowering its royalty from 1/4 to 1/8. Another way to look at it is that the additional 1/8 royalty was worth $8 million to Range. Betty Lou should have received 1/2 of that additional 1/8 royalty, so she should get 1/2 of that $8 million.
To my knowledge, the question of the lessee’s potential liability to a royalty owner like Betty Lou has not previously been addressed by the Supreme Court. This case seems to shut the door on that issue. But suppose a slightly different set of facts. Suppose that, instead of paying KCM a higher bonus, Range had agreed to assign to KCM’s sole shareholder a 1/8 overriding royalty on lease production, as part of the lease deal. If the additional 1/8 royalty is worth $8 million, the result is the same economically to Range. But under these facts, it seems to me that Range might have some liability. It looks more like Range is conspiring with KCM to deprive Betty Lou of her rights. Not Betty Lou’s facts, but a case can be made that, under some circumstances the lessee could be held liable for conspiring with its lessor.
The Court’s opinion can be found here.