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What Duty Does the Owner of an Texas Executive Interest in Minerals Owe to the Non-Executive Interest?

Texas oil and gas lawyers occasionally find themselves representing non-executive mineral owners. A non-executive mineral or royalty owner is someone who owns oil or gas royalty rights to a particular area of land, but who does not have the right to negotiate or sign a lease for the minerals and who usually does not have the right to receive bonus payments. The executive rights owner is the person who is has the exclusive right to execute oil and gas leases on a particular area of land and to receive bonus. Commonly, these relationships are created by a reservation in a deed, such as when someone sells their surface and mineral rights, including the right to negotiate an oil and gas lease, but reserves a non-participating royalty interest.

Recently, the Texas Supreme Court considered what duties are owed by the owner of an executive interest in minerals to the owners of the non-executive interests in the case of KCM Financial LLC v. Bradshaw. In this case, Bradshaw was the non-executive royalty owner and KCM Financial was the executive.

In this case, two deeds were executed in 1960 that reserved a non-participating royalty interest for Bradshaw of an undivided one-half of any future royalty, but not less than one-sixteenth share of gross production. In 2005, the executive KCM bought the land, and in 2006 KCM leased the land to lessee Range Resources for a one-eighth royalty interest and a 13 million dollar bonus. Nice payday for KCM!

Problems arose when the non-executive, Bradshaw, believed that she was getting less royalty than she was entitled to. Under the lease, Bradshaw was getting one-sixteenth of the royalty on production, but she believed that she should have been getting one-eighth. To say this another way, Bradshaw was getting a royalty that was below market-rate, and she asserted that KCM violated its duty to her in negotiating the lease and that KCM and Range were conspiring against her to pay her less than what she should have been paid.

Executive’s Duty To Non-Executive

The Court noted that “…the executive has autonomy in negotiating the terms of a mineral lease but does not have absolute discretion to determine the value of the non-executive interest” and that  “the executive is prohibited from engaging in acts of self-dealing that unfairly diminish the value of the non-executive interest”. The Court also stated that “in determining whether an executive has fulfilled its duty of utmost good faith and fair dealing in executing a mineral lease, the lease and the circumstances of its execution must be considered as a whole, and the failure to negotiate a market-rate royalty is but one relevant factor. Simply put, the executive’s failure to obtain a market-rate royalty does not conclusively establish a breach of duty, nor is it totally irrelevant”.

The Court found that the failure to obtain a market-rate royalty does not, in and of itself, constitute a breach of that duty. The Court found that in this case, fact issues existed as to whether KCM had violated its duties to Bradshaw, and so the case was sent back to the trial court for a trial of these issues.

Lessee Has No Duty to Non-Executive

Next, the Court considered whether a derivative liability claim can extend to the lessee. The Court determined that no fiduciary duty exists between the lessee  and the non-executive royalty holder, so long as the lessee is a third party acting in an arm’s length leasing transaction with the executive interest. In fact the Court stated that “(t)he evidence shows nothing more than a typical business transaction in which the parties reached a meeting of the minds as to terms mutually acceptable to both sides”.

This case includes a useful recap of the history of the law in this area of executive/non-executive rights and makes interesting reading if you are a non-participating royalty owner who would like to know more about your rights.