Last May, the San Antonio Court of Appeals issued an opinion in Texas Outfitters Limited v. Nicholson, No. 04-16-00392-CV, addressing the duty of holders of the mineral executive right to its non-executive mineral owner – a case now pending on application for writ of error in the Texas Supreme Court. It is the first significant appellate opinion on the duty of the executive since the Supreme Court’s decision in Lesley v. Veterans Land Board on the same topic. The case tells the remarkable story of a landowner’s failure to carry out its duty of “utmost fair dealing” in exercising – or in this case failing to exercise – its executive right.
The executive right is the power to lease minerals for oil and gas exploration and development. It is one of the sticks in the bundle of rights that make up the mineral estate. The executive right can be conveyed or reserved separately from the other rights of the mineral owner – the right to bonus, delay rental and royalty. When the right to lease the mineral estate is owned by a different party than the owner of the mineral estate, conflicts can arise between the two on whether, when and on what terms the executive should exercise its right. Courts have struggled to define what duty the executive holds to the non-executive mineral owner.
The two previous cases from the Texas Supreme Court, In re Bass, 113 S.W.3d 735 (Tex. 2003) and Lesley v. Texas Veterans Land Board, 352 S.W.3d 479 (Tex. 2011), sent mixed signals on the scope of the executive-rights holder’s duty. In Bass, the court held that the holder of the executive right had no duty to enter into an oil and gas lease, but only to exercise utmost fair dealing if it elected to lease. In Lesley, the court backed off its previous holding, deciding that the holder of the executive right could breach its duty by failing to lease – or in Lesley’s, case, imposing restrictive covenants on the land that made it impossible to lease.
In Texas Outfitters v. Nicholson, Texas Outfitters bought 1082 acres in Frio County from Dora Jo Carter for $1 million. Dora Jo and her family owned 50% of the minerals under the ranch, and the Hindes family owned the other 50%. Dora Jo conveyed to Texas Outfitters a 4.16% interest in the minerals under the ranch but also conveyed the executive right over her family’s reserved mineral interest.
Texas Outfitters developed a deer breeding and hunting operation on the ranch. In 2010, Texas Outfitters and the Hindes family began receiving offers to lease the ranch minerals. El Paso Exploration & Production Company offered a lease with a primary term of three years, a 25% royalty, and a $1,750/acre bonus. The Hindes family agreed to lease to El Paso on those terms, but Texas Outfitters did not. According to Dora Jo, Frank Fackovec, the owner of Texas Outfitters, told her that there would be no lease because he wanted to protect his hunting business.
The Carters and their lawyer then entered into negotiations with Frankovec to try to convince him to lease their mineral interest. In the ranch sale, the Carters financed a portion of the purchase price, taking a $263,000 note from Texas Outfitters. The Carters offered to forgive that note if Texas Outfitters would lease to El Paso. Frackovec refused. Frackovec offered to re-align the mineral ownership so that Texas Outfitters would each own 25% of the minerals, each with its own executive rights. Frackovec made no promise to lease is 25% mineral interest to El Paso, but said that, if he did lease, he would use his share of the bonus to pay off his $263,000 debt to the Carters. Frackovec also offered to sell the ranch back to the Carters for $4.2 million.
The Carters refused Frackovec’s offers and sued Texas Outfitters for breach of its duty as holder of executive rights on their mineral interest in the ranch. Texas Outfitters later sold the surface and its executive rights and minerals in the Ranch for $4.5 million.
The case was tried before the judge without a jury. The judge found that Texas Outfitters had breached its duty to the Carters and awarded them $867,654.32, the amount of bonus the Carters would have received had Texas Outfitters accepted El Paso’s lease offer.
The San Antonio Court of Appeals affirmed. It quoted the Supreme Court’s Lesley opinion that “an executive can breach its duty by refusing to lease ‘[i]f the refusal is arbitrary or motived by self-interest to the non-executive’s detriment.” In its findings of fact, the trial court found that, by refusing to lease, Frackovec gained for himself “unfettered use of the surface for its hunting operation,” and “the ability to sell its land at a large profit free of any oil and gas lease.” The court of appeals said there was ample evidence to support those findings. “Although protecting an existing use of the surface estate is a legitimate interest, an executive breaches its duty if it protects the surface estate by refusing to permit any mineral lease.” The court also frowned on Frackovec’s efforts to extract concessions from the Carters in exchange for his agreement to lease. “The evidence supports an inference that Texas Outfitters refused to lease not only to protect its existing surface use, but also to exact a benefit from the Carters at their expense.” In a footnote, the court said:
Alternatively, we hold an executive who unsuccessfully engages in acts of self-dealing to the non-executive’s detriment breaches its duty … as does an executive who successfully engages in acts of self-dealing that unfairly devalues the non-executive’s interest.
In other words, it is a breach of the executive’s duty to seek benefits for itself at the expense of the non-executive as a condition to its agreement to lease, whether or not it succeeds.
One of Texas Outfitters’ arguments was that the Carters put themselves in this situation and should have known better: the Carters “knowingly contracted for a situation in which they would have no say over when and how (or if) their minerals would be leased.” In rejecting this argument the court remarked: “it could also be said that Texas Outfitters knowingly contracted for a situation in which it would owe the Carters a fiduciary duty of utmost good faith and fair dealing if a mineral lease were offered.”
I always counsel caution a client who wants to engage in a transaction in which the executive rights are severed from the minerals. A client wanting to have executive rights over others’ minerals should understand its duty, and a client willing to give up its executive rights should understand the risks.