Louisiana Lender Not Liable for Lease Violations

Originally published by Charles Sartain.

Co-author Brittany Blakey*

The Louisiana Supreme Court’s reversal of the lower courts in Gloria’s Ranch, L.L.C. v. Tauren Expl., Inc. corrects a profound judicial mistake eliminates a source of anguish for Louisiana energy lenders and their borrowers. You might recall our report on the court of appeal opinion.

Facts:

Gloria’s Ranch granted an oil and gas lease to Tauren Exploration, who transferred an undivided 49% working interest to Cubic Energy. Cubic mortgaged its interest in several hundred leases, including Gloria’s Ranch, to Wells Fargo and assigned an override and a net profits interest as collateral. Tauren conveyed its 51% interest in the deep rights to EXCO.

Gloria’s Ranch demanded that the leasehold owners and Wells Fargo execute a recordable act evidencing that the lease expired for failure to produce in paying quantities.

Lower court proceedings

Gloria’s claim that attracted all the attention was the demand for damages from all defendants, including the lender. The damage award before the Supreme Court was $22 million for lost leasing opportunities, $242,000 in royalties, $484,000 in double royalties as a Mineral Code art. 140 penalty, and $936,000 in attorney fees. Most significant was the finding that lender Wells Fargo was solidarily liable with the other defendants for damages.

The big issue

Was mortgagee Wells Fargo solidarily liable as an “owner” of the lease under Mineral Code art. 207 and a “lessee” under art. 140?

In a victory for proper statutory construction, sound public policy, and the viability of the oil and gas industry in Louisiana, the Court held that Wells Fargo as mortgagee was not an “owner” under art. 207 and was therefore not liable for failure to release the lease and was not a “lessee” under art. 140, and therefore was not liable for failure to pay royalties.

The opinion was based on this analysis:

• Cubic maintained its working interest in the lease when it entered into the loan and mortgage. Wells Fargo acquired a security interest, not a working interest.
• Wells Fargo did not become an “owner” of the lease merely because it assumed rights of control under the loan documents. Such rights incidental to a mortgage and credit agreement do not rise to the level of ownership required under Mineral Code art 207.
• Under the Mineral Code, ownership rights are distinguishable from security rights. The mortgage and credit agreement provisions were typical of security contracts designed to protect collateral.
• The loan documents did not convey to Wells Fargo the critical right of a lessee in a mineral lease: to explore for and produce minerals.
• Acquisition of overriding royalty and net profits interests in no way transformed Wells Fargo’s status from a secured creditor to that of an owner. This goes back to a basic oil and gas principle: The owner of a mineral royalty has no executive rights; nor does he have the right to conduct operations to explore for or produce minerals, citing Mineral Code art. 81.

The Court applied the same analysis to the royalty claim. Under art. 140, a “lessee” is liable for failure to pay royalties that are due. Because Wells Fargo was not liable as a “former owner” under art. 207, it was not liable for unpaid royalties as a “lessee” under art. 140. Wells Fargo was not liable under those provisions.

Tauren’s liability

Tauren as owner of the shallow rights was solidarily liable for the damages because its failure to release the lease breached an indivisible obligation. Tauren’s conveyance of its deep rights to EXCO did not effect a severance of the lease.

Penalty for unpaid royalties – 2X or 3X?

The maximum damage award under art. 140 was twice the amount of unpaid royalties, not royalties plus twice the amount.

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Danny Dill and Marijohn Wilkin (Huh?), and Graham Parsons.

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*Brittany, a Gray Reed summer  associate, is a JD-MBA candidate at Baylor and a Texas Tech grad.

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