Face Challenges Confidently

441 Stroud Prod., LLC v. Hosford

Tuesday, September 1st, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
Stroud Prod., L.L.C. v. Hosford, 405 S.W.3d 794 (Tex. App.—Houston [1st Dist.] 2013, pet. denied) held that a lessee could intentionally washout an overriding royalty interest by allowing the burdened lease to terminate while acquiring an unburdened top lease. In 1978, lessor granted two leases (“Base Leases”) which were subsequently drilled, produced, and burdened by a combined 5% overriding royalty held by Hosford, et al. (“Hosford”). In December 2003, Stroud et al. (“Stroud”) acquired the Base Leases and assumed operations. In January 2004, production ceased because of a minor mechanical problem. In February 2004, Stroud acquired Top Leases on different terms on the same property. In April 2004, the Base Leases terminated for failure to resume production within the time permitted under the 90-day continuous operations clause. In May 2004, Stroud fixed the mechanical problem and promptly resumed production, but under the Top Leases. The assignments of overriding royalty to Hosford burdening the Base Leases did not contain renewal and extension clauses. Stroud refused to pay overriding royalty to Hosford. “Stroud admitted that he intentionally returned the well to production in June 2004, only after the [Base Leases] had terminated, [the Top 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 [Hosford’s] overriding royalty interests had been ‘washed out.’” There was no express surrender clause in the Base Leases.
The issue was whether Texas recognizes a cause of action for intentional termination of an overriding royalty interest. The court surveyed in detail relevant Texas cases on the duty a lessee owes to an overriding royalty interest holder under Texas law.  The court concluded 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 observed that the two Texas Supreme Court opinions on topic, Sunac Petroleum Corp. v. Parkes, and Ridge Oil Co. v. Guinn Investments, Inc., indicate that although the question of whether any duty is owed is uncertain under Texas law, the language of the controlling documents and the circumstances and relationships of the parties should be considered when making such a determination.
As to the circumstances and relationship of the parties, the court found no evidence of a formal fiduciary relationship between Stroud and Hosford and there was no special relationship of trust and confidence spanning over a long period of time. Thus, there was no relationship duty.
As to the language of the controlling documents, the court first observed that the assignments of overriding royalty did not include a renewal or extension clause, which some courts have suggested may provide some evidence of a fiduciary relationship or support a constructive trust remedy. However, those same courts then note that when the underlying lease has an express surrender clause, there can be no implied duty to keep the lease in effect. Thus, the court noted that a renewal clause, if it existed, could provide some evidence of a fiduciary relationship, but it would not be determinative on the issue. The Base Leases did not include an express surrender clause that would permit the lessee to terminate the leases at will and thereby support the conclusion that there is no duty owed by the lessee to the overriding royalty owner. However, at least one Texas court has held that the absence of an express surrender clause in the lease, even when there is a renewals and extensions clause in the assignment of overriding royalty, is not enough to impose a duty.
Here the court did not find anything in the assignment of the overriding royalty interest or the Base Leases that obligated Stroud to take other action to perpetuate the lease, and therefore, the absence of an express surrender clause in the Base Leases did not indicate some sort of special duty that Stroud owed Hosford. The court concluded that while a party that engages in conduct to intentionally wash-out an overriding royalty interest may be subject to liability, because here there was no evidence that Stroud violated any express or implied contractual duty and there was no evidence of the existence of a fiduciary or confidential relationship, Stroud did not commit an actionable wrong by intentionally terminating the Base Leases to extinguish the overriding royalty interest. There is a lengthy dissent which is generally based on the fact that there was no express surrender clause in the Base Leases. It reads the Base Leases into the assignment of overriding royalty interest, to conclude that lease clauses, such as the implied covenant to reasonably develop, created duties that the lessee owed to the overriding royalty owner.
This case appears to squarely raise the issue of the duty owed by the lessee to the holder of an overriding royalty interest in a “wash-out” transaction. This case holds there is none, in the absence of a renewals and extensions clause, if lessee is simply pursuing lessee’s own best interests.