Undisclosed Surface Lease Offers Important Reminders to Property Purchasers

Originally published by Tiffany Dowell.

 

The Eastland Court of Appeals recently issued an opinion in a case involving the purchase of land, a surface lease not disclosed by the buyer but noted in the title commitment, and claims of fraud.  [Read opinion here.]

Photo by Ingo Doerrie on Unsplash

Background

Parmelly owned 700 acres of land in Taylor County, Texas.  The land was naturally divided by a steep bluff into an “upper” and “lower” part.  The lower part of the property was about 225 acres.

In 1999, Parmelly signed a surface lease with Vulcan Construction Materials that covered most of the 700 acres, including at least a portion of the lower 225 acres.  The lease had a 20-year term and an option for Vulcan to extend for an additional 5-year term.  The lease gave Vulcan the right to remove rock, dump dirt and waste, to build plants, and to conduct other mining operations.  It also allowed Vulcan to object to other activities on the land that interfered with its operations.  Vulcan had mined rock on the upper portion of the property but had not conducted any operations on the lower 225 acres.

In 2013, Parmelly hired Nelson, the owner of a real estate firm, Nelson Farm & Ranch Properties, to sell the lower 225 acres.

Gary McCall, principal of McCall Motors, saw an advertisement for the property and called Bob Welborn, an agent for Nelson Farm & Ranch Properties.  McCall has been involved in over 160 real estate transactions.  McCall and Welborn visited the property on two or three occasions, and Gary saw the Vulcan mining operation on the upper part of the property.  The end of the quarry was within feet of the lower property.

McCall Motors decided to purchase the property.  They were not represented by a realtor.  Welborn prepared the sales contract on the “Farm and Ranch Contract” form provided by the Texas Real Estate Commission.  The purchase price was $1,500 per acre.  The form had a provision related to surface leases, which stated that prior to the execution of the contract, “Seller has provided Buyer with copies of written leases and given notice of oral leases listed below or on the attached exhibit.”  It also provided for a place to list leases that were permitted exceptions in the Title Policy: “the following leases will be permitted exceptions in the Title Policy and will not be a basis for objection to title” followed by blank lines in which Welborn typed “None at time of closing.”

First Texas Title Company was selected to prepare a commitment for title insurance and deliver to McCall Motors.  Pursuant to the sales contract, after McCall receive the title commitment, it could object in writing to “defects, exceptions, or encumbrances” reflected in the title commitment.  If no objections were made by the earlier of the closing date or 5 days after the receipt of the commitment, it waived the right to object to any listed defect, exception, or encumbrance.  McCall did not remember reading this clause prior to signing the contract.

On May 15, 2013, the title company provided McCall a title commitment that specifically listed as exceptions from coverage the Vulcan lease and at least two oil and gas leases that were recorded in the deed records.  McCall denied receiving the title commitment prior to closing, but at the closing on May 23, 2013, he signed a form acknowledging receipt of the title commitment and stating he had sufficient opportunity to review.   McCall testified that he knew a title commitment was important and that he had reviewed the commitments in almost every other real estate transaction in which he had been involved.   McCall testified that he chose to sign the document without reading it.

The sale closed and McCall Motors purchased the property subject to the Vulcan lease. McCall Motors made improvements on the property and sought to sell it to a buyer in 2015.  That buyer objected to the Vulcan lease when it was listed on their title commitment and refused to purchase.

Litigation

McCall Motors sued Parmelly, Nelson, the title Company, and the attorney and law firm involved in the transaction.  Prior to trial, McCall Motors settled with Parmelly for $40,000 plus half the future lease payments that Parmelly received from Vulcan.

A jury trial was held, and 11 members found that Nelson committed common law and statutory fraud, and that the title company failed to comply with its agreement to close the transaction in accordance with the parties’ contract. They found Nelson 70% responsible and the title company 30% responsible for McCall’s damages.  The jury entered a verdict, but the court increased the amount of damages based on the evidence.

Nelson appealed.

Opinion

The Court of appeals sided with Nelson, holding that McCall did not justifiably rely on Nelson’s statements.  [Read full opinion here.]

First, Nelson argued there was insufficient evidence to support the jury’s finding that Nelson committed common law and statutory fraud.  To prove common law fraud, McCall Motors had to prove: (1) the defendant made a false, material representation; (2) the defendant knew the representation was false or made it recklessly as a positive assertion without any knowledge of its truth; (3) the defendant intended to induce the plaintiff to act upon the representation; and (4) the plaintiff justifiably relied upon the representation, which caused the plaintiff injury.   To prove statutory fraud, McCall must show: (1) the transaction involves real estate or stock; (2) the defendant made a false representation of a past or existing material fact or made a promise to an act without the intention of fulfilling it; (3) the defendant made the false representation or promise for the purpose of inducing the claimant to enter into a contract; and (4) the plaintiff justifiably relied on the false representation or promise entering into the contract.

The key issue in this case is whether McCall’s reliance on Nelson’s statement that there were no leases on the property. There was a technical legal issue regarding a jury instruction that did not include the word “justifiable” in describing the reliance element, but for which Nelson failed to object.  The Court determined that even without the instruction expressly including the word “justifiable,” it was necessarily included within the jury charge related to reliance.

Thus, the Court outlined the law related to justifiable reliance.  In making this type of analysis, a Court must consider the parties’ relationship and their “individual characteristics, abilities, and appreciation of facts and circumstances.”   Additionally, the law provides that ” a person may not justifiably rely on a representation if there are red flags indicating such reliance is unwarranted.”  An example of this type of red flag is a plaintiff’s claimed reliance on a misrepresentation that the written contract unambiguously contradicts. Additionally, the defrauded party must exercise “ordinary care for the protection of his own interests and is charged with knowledge of all facts which would have been discovered by a reasonably prudent person similarly situated.” In other words, a plaintiff may not “blindly rely” on representations made by another when the plaintiff’s knowledge, experience, and background alert him to investigate the defendant’s representations before acting in reliance on those representations.

Applying this law to the facts at hand, the Court considered whether McCall’s reliance upon Nelson’s statement of “none at the time of closing” was justifiable.  “In this case, there were many ‘red flags’ that indicated that McCall Motors’ reliance on the statement that there would be no surface leases at the time of closing was unwarranted.”

First, the quarry operation was apparent and Gary McCall visited the property at least twice prior to purchase.  Although there were no mining activities on the lower portion of the property, the lower property was within feet of the quarry.

Second, the context of the “none at the time of closing” statement must be considered.  Those words were preceded by “the following leases will be permitted exceptions in the Title Policy and will not be a basis for objection to title.”  This could be read not to indicate that there were no leases, but instead, to indicate there would be no leases excepted from the Title Policy.

Third, the statement in the contract that there would be no surface leases at closing was contradicted by other provisions of the contract, including a statement that Parmelly would retain ownership and royalty for the “current” mineral leases on the property, which was an indication that the property was subject to an oil and gas lease.

Fourth, McCall Motors received a title commitment and had a limited amount of time to review and either object or accept title subject to the listed exceptions, which included the surface lease.

Finally, and most importantly for the Court, the title commitment gave notice that at least portions of the property were subject to the Vulcan lease.  Despite claiming he did not receive the commitment, McCall signed the acknowledgement at closing.  He is a “sophisticated businessman” who had been involved in over 160 transactions.  He admitted that he knew the significance of the title commitment and has read them in almost all of the real estate transactions he has been a part of.  The law presumes that a party signing a contract has read the terms, meaning the Court presumes McCall had knowledge of the Vulcan lease.

Thus, the court sustained Nelson’s first objection finding the evidence legally insufficient to support a finding the McCall Motors justifiably relied upon the misrepresentation by Nelson. The court reversed the judgment and entered a take nothing judgment for McCall on his claims against Nelson. The case was remanded for the consideration of Nelson’s claim for attorney’s fees.

Takeaways

As has become a theme on this blog, it is critically important to read any document before signing!  This applies to even something as simple as a statement that one has read a title commitment.  Here, despite claiming that he did not receive the commitment, McCall’s signature on the closing document stating that he had received it was problematic.

On a related note, anytime a person purchases property, carefully reviewing the title commitment is one of the most important steps to be taken.  The title commitment will (or at least should) list out all of the encumbrances on the property.  This will include items like leases, easements, and liens.  Although a seller should provide notice of these items, the title commitment is a good safety net to catch items that may have been omitted.  Here, although the seller did not disclose the existence of the Vulcan lease, the title commitment listed it and that provided the purchaser that notice.

Lastly, we should not overlook the visual inspection of property.  Here, the fact that McCall had been to the property at least twice and saw the quarry so near to the bounds of the property he was purchasing should have triggered him to ask questions or do some research to determine whether there was a lease on the 225 acres.  If one is inspecting a property, it is important to pay attention, note anything that seems potentially problematic or out of the ordinary, and take the time to follow up on those issues.

 

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