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“Royalty Lease” – Lessor Beware

In Ridge Natural Resources v. Double Eagle Royalty, recently decided by the El Paso Court of Appeals, James and Jolinda McDaniel signed a “Royalty Lease” to Ridge, reading as follows:

Oil and Gas Royalty Lease

THIS LEASE AGREEMENT is made as of the 10th day of October, 2016 between

[the McDaniels]

as Lessor (whether one or more) … and Ridge Natural Resources … as Lessee. …

1. In consideration of ten dollars ($10.00) and other good and valuable consideration in hand paid and the covenants herein contained, Lessor hereby grants, leases and lets exclusively to Lessee, subject to the reservation contained herein, all of Lessor’s royalty interest in and to all of the oil, gas and other minerals produced and saved from the hereinafter described lands (the ‘Subject Interest’), such Subject Interest to include all proceeds thereof in and to the rights, rentals, royalties and other benefits accrued, accruing and/or to accrue and the right to demand, collect and receive same, hereinafter called leased premises:
[Legal description omitted]
2. This royalty lease, shall be in force for a primary term of 5 years from the date hereof, and for as long thereafter as oil or gas or other substances covered hereby are produced in paying quantities from the leased premises or from lands pooled therewith.
3. As Royalty on the Subject Interest leased to Lessee herein, Lessor reserves an equal one-fourth (25%) part of the Royalty and other proceeds from the sale of all oil, gas and condensate produced and saved from said Land and the Subject Interested lease to Lessee herein.
4. Lessor hereby expressly represents and warrants that no representation, promise or other statement that is not herein expressed has been made to Lessor in executing this Royalty Lease Document and Lessor did not rely on any representation, promise or other statement made by Lessee and/or Lessee’s agent and/or employees, relating to this Royalty Lease or the subject matter thereof, except as set forth herein, and it is the Lessor’s express intent to fully disclaim and disavow reliance on any such representation, promise or statement. Lessor expressly acknowledges that this Royalty Lease does not grant Lessee the right to explore for or produce oil, gas, or minerals from the leased premises. […]

The instrument also contained an arbitration clause:
In the event of any dispute(s), claim or controversy arising out of or relating to this contract or the breach, termination, enforcement, interpretation or validity thereof, including the determination of the scope or applicability of this agreement to arbitrate, the parties agree to participate in at least four (4) hours of mediation in accordance with the commercial mediation rules of the American Arbitration Association before having recourse to arbitration. If the mediation procedure provided for herein does not resolve any such dispute, the parties agree that all disputes between the parties shall be resolved solely by binding arbitration administered by the American Arbitration Association in accordance with its commercial arbitration rules pursuant to the Texas General Arbitration Act. The parties expressly exclude the application of the Federal Arbitration Act. The arbitration shall be administered by JAMS pursuant to its Comprehensive Arbitration Rules and Procedures and in accordance with the Expedited Procedures in those Rules. All proceedings shall be conducted in the City of San Antonio, State of Texas. There shall be one arbitrator. The arbitrator shall apply the internal laws of the State of Texas. … The term ‘dispute(s)’ shall include, but is not limited to all claims, demands and causes of action of any nature, whether in contract or in tort, at law or in equity, or arising under or by virtue of any statute or regulation or judicial reasons, that are now recognized by law or that may be created or recognized in the future, for resulting past, present and future personal injuries, contract damages, intentional and/or malicious conduct, actual and/or constructive fraud, statutory and/or common law fraud, class action suit, misrepresentations of any kind and/or character, liable [sic], slander, negligence, gross negligence, and/or deceptive trade practice/consumer protection act damages, all attorney’s fees and all penalties of any kind, prejudgment interest and costs of court by virtue of the matters alleged and/or matters arising between parties. … The parties hereby waive any rights to punitive or exemplary damages and the arbitrator will not have the authority to award exemplary or punitive damages to either party. […]

At the time the McDaniels signed this agreement, the property was subject to an oil and gas lease.  Ridge assured them that was not a problem. They paid the McDaniels $325 per net royalty acre, for a total of $104,000.00, for the “Royalty Lease.” After they signed this agreement, the McDaniels sold their mineral interest to Double Eagle and assigned to Double Eagle any claims they would have against Ridge; and Double Eagle filed suit against Ridge, alleging that the “Royalty Lease” was invalid and procured by fraud.

Ridge sought to invoke the arbitration clause to require Double Eagle to litigate its claims before an arbitrator. The trial court refused to order arbitration, but the Court of Appeals reversed, holding that the arbitration clause was binding on Double Eagle, as successor to the McDaniels. So the Court of Appeals did not opine on the validity of the “Royalty Lease.” It did discuss the instrument:

Jolinda McDaniel testified in an affidavit that she believed the lease offer was for a traditional top lease.1 In fact, although the interpretation and validity of the interest conveyed by the lease are in dispute, the contract the McDaniels signed appears to be more akin to a non-participating royalty agreement2 that entitled Ridge to 75 percent of royalties, but that did not grant Ridge any executive rights or require Ridge to perform any exploration or development itself.3 Although Ridge referenced a ¼-royalty interest in the offer letter, the terms of the lease actually meant that after signing the offer and receiving $104,000 each, the McDaniels would retain a fourth—or 25 percent—of the original royalty interest. The thorny issue of defining the exact nature of that royalty interest is not before the Court in this case, and the parties in their briefs point us to no record evidence as to what the precise estimated value of the Disputed Interest may be.

Ridge and other companies are apparently using “Royalty Leases” to buy royalty interests, leading the seller to believe they are signing a top lease.

Several years ago the Texas Legislature attempted to protect mineral and royalty owners against offers from unscrupulous buyers by passing Section 151 of the Texas Property Code:

(a) A person who mails to the owner of a mineral or royalty interest an offer to purchase only the mineral or royalty interest, it being understood that for the purpose of this section the taking of an oil, gas, or mineral lease shall not be deemed a purchase of a mineral or royalty interest, and encloses an instrument of conveyance of only the mineral or royalty interest and a draft or other instrument, as defined in Section 3.104, Business & Commerce Code, providing for payment for that interest shall include in the offer a conspicuous statement printed in a type style that is approximately the same size as 14-point type style or larger and is in substantially the following form:
(b) A person who conveys a mineral or royalty interest as provided by Subsection (a) may bring suit against the purchaser of the interest if:
(1) the purchaser did not give the notice required by Subsection (a); and
(2) the person has given 30 days’ written notice to the purchaser that a suit will be filed unless the matter is otherwise resolved.
(c) A plaintiff who prevails in a suit under Subsection (b) may recover from the initial purchaser of the mineral or royalty interest the greater of:
(1) $100; or
(2) an amount up to the difference between the amount paid by the purchaser for the mineral or royalty interest and the fair market value of the mineral or royalty interest at the time of the sale.
(d) The prevailing party in a suit under Subsection (b) may recover:
(1) court costs; and
(2) reasonable attorney’s fees.
(e) A person must bring a suit under Subsection (b) not later than the second anniversary of the date the person executed the conveyance.
(f) The remedy provided under this section shall be in addition to any other remedies existing under law, excluding rescission or other remedies that would make the conveyance of the mineral or royalty interest void or of no force and effect.
The court in Ridge discusses this statute but does not rule whether it would apply to a “Royalty Lease.” A dissenting opinion in Ridge would hold that the arbitration clause is not enforceable and Double Eagle should be able to try its claim in the trial court.
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