Oil and Gas Lawyer Blog
Last week the Texas Supreme Court handed down its opinion in Texas Outfitters, Limited, LLC v. Nicholson, No. 17-0509, once again addressing the duty of the holder of executive rights to minerals owned by another. The Court affirmed a judgment of $867,654.32 plus interest and costs against Texas Outfitters for breaching that duty.
Dora Jo Carter owned the surface estate of 1,082 acres of land in Frio County. She and her two children owned 50% of the minerals; the other 50% were owned by the Hindes Family. In 2002 the Carters sold the land to Texas Outfitters, owned by Frank Fackovec, for $1 million, financing a part of the purchase price. Fackovec intended to live on the ranch and operate a hunting business. The Carters sold Texas Outfitters 1/24 of the minerals along with the land, and also conveyed to Texas Outfitters the exclusive right to lease the 11/24 mineral interest retained by the Carters. Fancovec wanted the right to lease the entire 50% mineral interest to be sure his surface estate was protected if and when oil and gas development took please. This right to lease the Carters’ minerals, the executive right, became the source of the later controversy.
In June 2010 the Hindes family leased their 50% mineral interest in the ranch to El Paso Exploration for $1,750 per acre and 25% royalty. El Paso made the same offer to Fackovec, but he declined the offer, despite the Carters’ request that he accept it. The Carters and Facovec then had settlement negotiations, resulting in a tentative settlement in which (1) Texas Outfitters would convey back to the Carters the executive rights to their 11/24 mineral interest, (2) the parties would agree to as-yet unspecified restrictive covenants burdening the mineral estate for the protection of the surface estate, (3) the Carters would forgive $263,000 of the note they held from Texas Outfitters, and the parties would sign a lease to El Paso. This settlement later fell apart over failure to reach agreement on the terms of the restrictive covenants. The Carters sued Texas Outfitters and Fackovec in June 2011, alleging that he had breached his duty as holder of their executive rights by refusing to lease to El Paso.
Subsequently, drilling in the area revealed that the ranch was not as prospective for oil and gas as had been thought. In 2012, Texas Outfitters sold the ranch for approximately $3.5 million.
After a trial before the court without a jury, the trial court found that Texas Outfitters had breached its duty to the Carters and awarded them the amount they would have received in bonus if it had leased to El Paso. The trial court made extensive findings of fact, which Texas Outfitters did not challenge on appeal, except for the ultimate fact that Texas Outfitters had breached its duty. The court of appeals in San Antonio affirmed.
The Court’s opinion reviews its prior cases on the duty of the holder of the executive right: Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984), In re Bass, 113 S.W.3d 735 (Tex. 2003), Lesley v. Veterans Land Bd. of State, 352 S.W.3d 479 (Tex. 2011), and KCM Financial LLC v. Bradshaw, 457 S.W.3d 70 (Tex. 2015). The Court said that, based on these prior cases, “the ‘controlling inquiry’ in ascertaining whether an executive breached his duty to a non-executive [is] whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.” The Court said that this test applies whether the alleged conduct consists of leasing or failing to lease. The Court cautioned that “evaluating compliance with the executive duty is rarely straightforward and is heavily dependent on the facts and circumstances.” Examining the facts and circumstances of this case, the Court found that there was sufficient evidence to affirm the judgment.
The Court said that “an executive generally does not breach his duty by declining a lease in honest anticipation of obtaining better terms for all.” The Court analogized the test to the business judgment rule; that rule protects corporate officers and directors, who owe a fiduciary duty to the corporation, from liability for conduct that is within the honest exercise of their business judgment. But the Court found sufficient evidence that Texas Outfitters had breached its duty by refusing to lease to El Paso in order to benefit its surface interest in the ranch. Texas Outfitters had “crossed the line” “from lawfully promoting his own surface interest to unlawfully doing so at the expense of the non-executive interest, thereby engaging in self-dealing that unfairly diminishes the value of that interest.” “We certainly do not hold that an executive must always accept an offer to lease both the executive’s and the non-executive’s mineral interests when the non-executive wishes to accept. But we also do not hold that an executive is never required to accept such an offer.”
In 2003, the Court held in In re: Bass that the holder of the executive right has no duty to lease. The plaintiff in that case owned a royalty interest in lands owned by Bass, and Bass refused to lease the land. The Court said that Bass had not breached any duty to the royalty owner by refusing to lease. Although the Court in Leslie and Texas Outfitters did not expressly overrule Bass, it made clear that refusal to lease may breach the executive’s duty.
The executive right can be severed from the mineral estate in two ways: by a grant or reservation of a royalty interest, or by a grant or reservation of a mineral interest in which the executive right to lease part of the mineral interest granted or retained is given to the holder of another’s mineral interest. Allegations of breach of the executive’s duty to the holder of a royalty interest generally involve situations like Manges v. Guerra, where the mineral owner leases for a below-market royalty in order to obtain a benefit for himself, such as a larger bonus or benefits to the surface estate. Allegations of breach of the executive’s duty to the non-executive mineral owner generally arise in situations like Texas Outfitters where the executive owns the surface and unfairly seeks to protect his interest in the surface to the detriment of the non-executive mineral owner.
Holders of executive rights must be cognizant of their duty to the non-executive interest owner. If, as in Texas Outfitters, an opportunity to lease is lost, the non-executive interest owner may seek to second-guess the decision of the executive interest owner not to lease.