Executive Right Holder Liable for Refusing to Lease

Originally published by Charles Sartain.

Co-authors Niloufar Hafizi and Mauri Hinterlong

In resolving disputes among the mineral interest family, there is no bright-line rule delineating the duty of the executive right holder. In Texas Outfitters Limited v. Nicholson, the Texas Supreme Court explained why. The Court last addressed executive rights in 2015 in KCM Financial v. Bradshaw, where the executive allegedly colluded with a lessee for lease terms favoring itself at the expense of the non-executive. Texas Outfitters presented an oppportunity for the Court to apply the KCM guidelines to a different scenario: whether the executive breached the duty by refusing to lease.

(Spoiler alert: Yes.)

Background

The Carters and the Hindes each owned 50% of the minerals to the 1,082 acre Derby Ranch in Frio County. The Carters owned the surface. The Carters sold the surface, a 4.16% mineral royalty interest, and the executive right to Texas Outfitters, a hunting company, leaving themselves with a non-executive right to 45.84% of the minerals.

Outfitters began receiving, and rejecting, lease offers for the 50% interest it and the Carters owned. One such offer was from El Paso for a 25% royalty and $1,750-per-acre bonus. Not coincidentally, the Hindses has already leased to El Paso on identical terms. When Outfitters rejected the El Paso lease, it knew the Carters wanted it to accept.

The Parties tried but failed to reach an agreement that would result in a lease and surface protections for Outfitters. Outfitters received two more lease offers which were withdrawn, the first when the prospective lessee learned El Paso had leased the other 50%.

The Carters sued Outfitters for breaching the executive’s duty of utmost good faith and fair dealing. A bench trial resulted in a judgment for the Carters for the amount they would have received in bonuses had Outfitters leased to El Paso: $867,654.32. The court of appeals affirmed.

The Supreme Court sets the new standard

Outfitters claimed all it had done was “gamble” on receiving a lease offer better than El Paso’s. The Supreme Court disagreed and affirmed the result, although not the appellate court’s application of the rule. The lower court had incorrectly distinguished two standards: The Bradshaw standard for breaches involving a lease, and the Lesley standard for refusals to lease.

The Supreme Court clarified that one inquiry guides breach of executive duty cases, regardless of whether the executive has leased or failed to lease. There is but one “controlling inquiry”: whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.

Evidence of wrongdoing

What had Outfitters done to benefit itself in a manner that unfairly diminished the value of the Carters’ interest?

• Outfitters refused the El Paso lease, which was higher in bonus and royalty than the previous offer, knowing that the Carters owned a much greater mineral interest and wanted the lease.
• Outfitters knew there would be fewer options for leasing to another operator once El Paso had a lease on the other 50%, but refused El Paso anyway.
• The later prospective lessee’s withdrawal of its offer because of the El Paso lease confirmed that Outfitters’ refusal led to less competition, reducing the value of the Carters’ minerals.
• The courts apparently believed the Carters’ claim that Outfitters stated it was refusing the lease due to its hunting operations, not because it was waiting for a better offer.
• Outfitters benefited from denying to lease by running hunting operations on the surface and then selling the Ranch for more than it could have, had a lease existed.

The Court agreed with the trial court that that Outfitters had self-dealt at the Carters’ expense.

What have we learned about executive right jurisprudence?

This case confirms that the executive’s duty defies easy definition and bright-line standards. The Court emphasized that executive breach inquiries are “heavily dependent on the facts and circumstances”; none of the single facts in this case were dispositive. Also, there is now the one guiding inquiry

This result also puts into perspective the purposes of the executive right. Scholars have pointed to two:

• to protect the surface owner’s rights, and
• to facilitate leasing and development when mineral interests are fractionalized.

The Court found the second rationale more convincing. Scholarly debate aside, Outfitters reinforces the message that surface protection is not the only goal an executive is allowed to pursue – especially if a co-owner has leased.

Ready for more on this subject?

Today’s co-authors Nikki and Mauri will speak on this topic at the 32nd Annual Energy Law Institute presented by the South Texas College of Law.

And today’s musical interlude.

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

from Texas Bar Today http://bit.ly/2Gjm18c
via Abogado Aly Website