Face Challenges Confidently

013 Gavenda v. Strata Energy, Inc.

Thursday, September 3rd, 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.
In Gavenda v. Strata Energy, Inc., 705 S.W.2d 690 (Tex. 1986), the Supreme Court refused to find division orders a bar to recovery of underpaid royalties. The case arose because of the misreading of a 15-year term royalty which gave the plaintiffs an undivided 1/2 nonparticipating royalty in all oil and gas produced from the land. An oil and gas lease providing for a 1/8 royalty was later executed on the land subject to the term royalty. The operator misread the deed containing the term royalty as reserving 1/2 of royalty in the plaintiffs, thus concluding that the royalty owners were entitled to 1/16 of the gross production under the oil and gas lease. The royalty owners apparently read the reservation the same way initially because they executed division orders prepared by the operator reflecting their interest to be a 1/16 royalty. The operator paid royalty to the plaintiffs based on the division order. The royalty owners eventually discovered their error, however, and revoked the division order before the termination of their 15-year term. They then filed suit for the $2.4 million that  they had been underpaid.
The trial court ruled for the operator and held that division orders are binding until revoked. The Court of Appeals affirmed. The Texas Supreme Court reversed in part, holding that division orders are NOT binding until revoked IF (1) the operator prepares the erroneous orders and (2) receives a positive benefit from the mistake. The operator retained at least a part of the 7/16ths royalty due to plaintiffs. The Court held the operator was liable to royalty owners for the amount of underpaid royalty that the operator had retained, and remanded the case to the trial court to determine the amount of royalties owed. The most important factor to the Court appears to be the unjust enrichment of the operator. The Court does not abolish the general rule that division orders are binding upon underpaid royalty owners until revoked but it does severely limit it. The decision makes it difficult to predict what facts will give rise to exposure for operators in the future.
On remand, the trial court entered judgment in favor of the royalty owners for unpaid royalties, without any credit or offset for the portion of the plaintiff’s royalties paid by the operator to overriding royalty interest owners and other working interest owners. The only credit given was for payment of royalties to the mineral owner and lessor. The operator appealed. In St ra ta En er gy, Inc. v. Gavenda, 753 S.W.2d 789 (Tex. App.–Houston [14th Dist.] 1988 no writ), the court of appeals upheld the trial court’s judgment on this point. The overriding royalty interests were created out of the working interest. Similarly, the other working interest owners were assignees of the operator. The court’s holding makes it clear that in its view the operator “benefits” when the plaintiffs’ funds are used to discharge the operator’s obligations to interests that were created out of its leasehold estate.
The second issue addressed by the Strata court of appeals was the prejudgment interest rate applicable to the amount owed to the royalty owners.  In Texas, depending on the circumstances, prejudgment interest can be awarded at either the statutory rate of 6% under Tex. Rev. Civ. Stat. Ann. art. 5069-1.03 (Vernon 1987), or at an equitable rate as outlined in Cavner v. Quality Control Parking, Inc., 696 S.W.2d 549 (Tex. 1985). The Cavner rate is that rate existing on the date a judgment is rendered. The statutory rate is generally the lower rate. The statutory rate applies to contract cases when the sum owing is ascertainable and when no specific rate of interest has been agreed upon by the parties. The Cavner rate is applied in breach of contract actions when the damages are unascertainable. The parties in this action disagree over whether this cause of action is based upon contract. The court of appeals concluded that it did not have to decide if the cause of action was based upon contract because the Texas Supreme Court had previously awarded attorney’s foes to the royalty owners under Tex. Civ. Prac. & Rem. Code Ann. §38.001 (Vernon 1986). The court of appeals concluded that, because attorney’s fees were awarded by the Supreme Court, this action must be based upon a contact. As the damages were ascertainable by a simple mathematical calculation, the court of appeals applied the lower statutory rate.