A recent Texas case decided by the San Antonio Court of Appeals, Texas Outfitters Limited, LLC v. Nicholson, offers some lessons on an executive rights owner’s fiduciary duties to the non-executive mineral owner in the context of oil and gas leases. At trial, the executive interest owner, Texas Outfitters, was found to have breached its fiduciary duty and a judgment of $867,654.32 was awarded to the non-executive.
What is “The Executive Right”?
Under Texas law and under the laws of most states, real property can have two co-existing estates – the surface estate and the mineral estate (covering minerals, oil, and gas below the surface). As the Texas Supreme Court has held, the property rights granted by the mineral estate are a “bundle” of rights and one of the “sticks” in the bundle is called the “executive right.” In general, the executive right is the right to make decisions affecting the exploration and development of the mineral estate and, more specifically, is the right to decide whether to execute a mineral lease and to determine the terms of the lease. These concepts were discussed by the Texas Supreme Court in Lesley v. Veterans Land Board of Texas, 352 S.W.3d 479 (Tex. 2011). As discussed in this article, holders of the executive rights sometimes owe fiduciary duties to any non-executive co-tenants.
Texas Outfitters involved a 1,082-acre property known as Derby Ranch in Frio County. The surface estate was wholly owned by Dora Jo Carter; the mineral estate was owned 50%-50% by Ms. Carter and another branch of the Carter family, the Hindeses. In 2002, Texas Outfitters bought the surface estate, the executive rights and 4.16% of the royalty interest in the mineral estate from Ms. Carter for $1 million. Importantly, Texas Outfitters wanted the surface estate for the purpose of operating a hunting business.
What are the Fiduciary Duties Owed by the Holder of the Executive Right?
The holder of the executive rights owes a duty of “utmost fair dealing” to the non-executive owner, meaning that executive cannot engage in any activities that gets the executive a better deal than the non-executive. An executive can sometimes breach its fiduciary duties by executing a lease, and sometimes by not executing a lease. For example, in KCM Financial LLC v. Bradshaw, 457 S.W.3d 70 (Tex. 2015), the executive signed a lease with a sub-market royalty rate and in return got an above-market bonus payable only to the executive. This was held to be self-dealing and a breach of the executive’s fiduciary duty. Whatever deal the executive bargains for, the non-executive must generally get the same deal.
By contrast, in Texas Outfitters, the executive refused to execute a lease and was charged by the non-executive, Dora Jo Carter, of self-dealing. Carter claimed that by refusing to sign lease, the executive gained for itself unfettered use of the surface for its hunting business and the ability to sell the surface free of any oil and gas lease. Indeed, Texas Outfitters sold the surface estate later and made a profit of $2.5 million on the sale.
As noted, Texas Outfitters lost at trial and the trial court judgment was affirmed by the Court of Appeals. The Court of Appeals likened this case to the Lesley case. Lesley involved 4,100 acres of land southwest of Fort Worth. The surface estate was sold to a housing developer (along with the executive right), but the mineral estate was reserved by the Lesley family and others. The developer platted the property into “Mountain Lakes,” a residential housing subdivision of over 1,200 lots, and added restrictive covenants for each lot forbidding any sort of commercial oil drilling, mining, etc. The covenants were added to protect the financial and ascetic value of each lot and the housing development as a whole. However, it seemed that “Mountain Lakes” was over a lot of shale oil. The Lesley Family sued claiming that the developer and the lot owners breached their fiduciary duties of utmost fair dealing. The Court of Appeals agreed and make clear that an executive cannot protect or enhance the surface estate at the expense of non-executive holders of mineral rights.
The Texas Outfitters case is currently on appeal to the Texas Supreme Court.
If you have questions about executive rights, contact attorney Aimee Hess at 214-236-9936 or toll-free at 888-818-5880. Ms. Hess focuses her practice on oil and gas law.