Face Challenges Confidently

040 Dearing, Inc. v. Spiller

Friday, September 4th, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of some significance to you.
Dearing, Inc. v. Spiller, 824 S.W.2d 728 (Tex. App.–Fort Worth 1992, no writ), is another case involving the duty owed by the holder of the executive rights to a nonparticipating mineral or royalty owner. Dearing owned part of the minerals in fee and held the executive right over the rest of the minerals in a 600 acre tract. The acreage was leased to Shell and held by a single old well when the area got “hot” in the 1980’s. Dearing got several offers to lease, and Dearing eventually bought out Shell in order to pursue new development. Dearing then let the Shell lease terminate and leased the entire tract to a Dearing-controlled company. The Dearing lease was clearlyless favorable for the lessor than the other offers Dearing received.
Held: Dearing breached the duty of utmost good faith owed to the nonparticipating mineral owner. The Dearing lease was canceled, Dearing’s executive rights were canceled, the nonparticipating mineral owners were established as cotenants, an accounting was ordered on the basis of the cotenancy, and exemplary damages of $300,000 were assessed. The court followed the landmark decision in Manges v. Guerra in finding that the duty of “utmost good faith” is just one step below a fiduciary duty and that a breach of that duty will support an award of exemplary damages. Executing a lease that complies with the minimum standard royalty established by the deed creating the executive interest (“a royalty of not less than the usual one-eighth”) does not necessarily comply with the duty to exercise the “utmost good faith.” Generally, when a party having executive leasing privileges enters into a transaction in which he and the non-executive mineral holders are both interested, and the executive is authorized to act for both parties, he must exact for the non-executive every benefit that he exacts for himself. An executive is forbidden from self-dealing through spouses, children, agents (including, as here, closely held corporations), employees, and all others whose interests are closely identified with those of the fiduciary. Reliance upon the advice of counsel is not a defense.
The case is another in a recent series of cases exploring the limits of the duty owed by the executive rights holder to the nonparticipating mineral owner. It is significant because it further clarifies the potential consequences of a breach of that duty. Exemplary damages should scare all possible defendants because the breach of the duty, the award of exemplary damages, and the amount of exemplary damages are jury issues. Whether the lease as executed complies with the duty cannot be known until the jury speaks. Cancellation of the lease and the establishment of a cotenancy may be an extremely unwelcome surprise for the “innocent” lessee. If the nonparticipating mineral interest is suddenly transformed into an unleased mineral interest in (for example) ½ of the minerals, the rate of return and other economics of drilling that well (which has probably already been drilled) are dramatically altered. The prudent operator should routinely call for lease ratifications by nonparticipating royalty owners, although this is far from a satisfactory solution. There is no assurance that a nonparticipating royalty owner will cooperate or can be leveraged into cooperating, and even a ratification might be subject to rescission if the nonparticipating owner can establish a fraud claim against the holder of the executive rights.