Lessees who pay overriding royalty interests are obliged to continue honoring those ORIs with every lease renewal or extension, without exception. Or are they? That’s now a question for the state’s Supreme Court.
Do pesky overrides give you issues? The Supreme Court may soon provide a solution to that particular problem. The high Court has recently been petitioned to review a decision rendered by the Court of Appeals of the First District of Texas, which found that a Lessee’s “wash-out” of several overriding royalty interests (occurring when Lessee allowed the old leases to lapse and subsequently took new leases—minus the overrides) was not actionable.
In the suit, the original leases were taken in 1978. Those leases had one-year primary terms, and 90-day continuous drilling/rework clauses. The original Lessee granted several overriding royalty interests (“ORI”). The Leases were assigned several times, and due to continuous production, the ORI owners continued to receive their share of production.
In late 2003/early 2004, Stroud Production became interested in acquiring the leases, and hired a landman to investigate. Plantation Petroleum Corporation (“Plantation”), owned and operated by Robert Stroud (who, not coincidentally, also owned Stroud Production), purchased the leases on December 1, 2003. Stroud Production was the operator of the leases, all of which were held by a single producing well.
In January of 2004, the case evidence showed that Stroud Production’s landman discussed with Stroud the assignments conveying the ORIs. Stroud’s landman noted that none of the ORI assignments contained “renewals and extensions” clauses. The evidence established that “‘renewals and extensions’ clauses may be used to protect overriding royalty interests by ensuring that such interests apply to any leases that qualify as renewals or extensions of prior leases.”
Just a few days after this discussion, a “polished rod” on the well broke, and production ceased. No repairs were ordered. The lease ultimately terminated under its own provisions. The appeals court notes in its opinion that “Stroud admitted that he intentionally returned the well to production in June 2004 only after the [Leases] had terminated, new leases had been obtained, and the 90-day continuous-operations period had passed. He also admitted that he ‘did not want any overriding royalty interest on the new leases’ and appellees’ overriding royalty interests had been ‘washed out.’”
The ORI owners filed a lawsuit. The trial court dismissed the ORI owners’ claims of breach of duty of good faith and fair dealing, fraudulent concealment, and breach of implied covenant to develop. The jury, however, found that Plantation, Stroud Production, and Stroud were liable for intentionally terminating the Leases and not paying the ORI owners the agreed-upon ORI.
Plantation, Stroud Production, and Stroud appealed. There, they argued that they did not have a contractual duty to perpetuate the original leases for the benefit of the ORI owners, nor did they have a fiduciary duty. The Appellate Court found that while there was no evidence that showed that any of the defendants intentionally broke the rod, there was evidence that they intentionally terminated the lease by electing not to repair the rod. The Court also acknowledged that the defendants financially benefitted from the expiration of the Leases.
The Court reviewed and analyzed several Texas cases that dealt with the same or similar issues. After its review, The Court determined that “no Texas court has yet recognized that a lessee generally owes any type of duty, whether it be an implied contractual covenant or a fiduciary-type duty, to protect the interest of an overriding royalty interest holder so as to require the lessee to make repairs to well equipment, perpetuate the lease, and ensure that such overriding interests are not extinguished.” The Court held that the language of the controlling document must be considered as well as the relationship between the parties. In its opinion, the Court determined that “there [is] no evidence of any special relationship of trust and confidence between [ORI owners] and Plantation.” Further, the Court noted that “the assignments granting appellees their overriding royalty interests did not contain any renewals or extensions clauses.”
Here, the Court held, the ORI owners could not point to “anything in the assignments of the overriding royalty interests or [Leases] that obligated the Stroud defendants to repair the polished rod on the broken well or take other action to perpetuate the [Leases].” Appellees have also not cited any contractual provision that would have precluded the lessee and the lessors from entering into new leases. Therefore, the Court concluded, the Stroud defendants did not commit “an actionable wrong by intentionally terminating the Leases to extinguish the overriding royalty interests and acquiring new leases with the lessors.”
We now must watch to see if the Texas Supreme Court agrees to review the Appellate Court decision. As always, any decision by the high Court offers guidance. If the Supreme Court agrees to review, we will quite likely have new and guiding law regarding the termination of overriding royalty interests from one lease to the next.