Face Challenges Confidently

420 City of Houston v. Trail Enterprises, Inc.

Monday, September 7th, 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.
The City of Houston v. Trail Enterprises, Inc., 377 S.W.3d 873 (Tex. App.—Houston [14th Dist.] 2012, pet. denied),  held that an ordinance enacted by the City of Houston (“City”) restricting the drilling of oil and gas wells did not constitute a compensable taking.  In 1967, the City enacted an ordinance that restricted drilling new oil and gas wells in the City or its extraterritorial jurisdiction (“ETJ”) due to the proximity of Lake Houston, a major source of drinking water for the City.  In 1977, the ordinance was limited to the ETJ.  In 1996, the property of various landowners (“Landowners”) located in the ETJ was annexed into the City, ending drilling restrictions.  In 1997, the City changed the ordinance, imposing drilling restrictions in both the City and the ETJ.  No new drilling occurred during the time period between 1996 when the drilling restrictions were not in place and 1997 when they went into effect for Landowners’ property.  Pre-1967 wells on the property continued to produce during the prohibition on drilling new wells.   The trial court concluded the 1997 ordinance was a compensable taking, awarding approximately $17 million to Landowners and the non-recoverable oil and gas to the City.  Both sides appealed, and the Court of Appeals reversed and rendered for the City.
In considering whether the regulation constitutes a taking, the court relied on the Penn Central analysis as set out by the U.S. Supreme Court in Penn Central Transportation Co. v. City of New York  and as later adopted by the Texas Supreme Court.   The Penn Central analysis is fact-specific and involves a determination of whether justice requires the government to compensate for an economic injury caused by governmental action.   The court noted that the Penn Central analysis is not required where an actual physical invasion occurs, when the regulation denies the owner all economic benefits from the use of his land, or where the regulation does not advance a legitimate state interest.   Because Landowners did not allege facts to support any of these circumstances, the court applied Penn Central’s balancing of the public’s interest against the private landowner’s interest, with special attention to three factors: “(1) the character of the governmental action; (2) the extent to which the regulation has interfered with reasonable and distinct investment-backed expectations; and (3) the economic impact of the regulations on the claimant.”
In analyzing the first factor, the court reviewed the ordinance and declared that the express purpose, to protect the City’s public water supply, was immensely important. Given the fact that drilling could possibly pollute the lake, the court concluded that “the first factor weighs heavily in favor of the City and against a finding of compensable taking.”
For the second factor, reasonable investment-backed expectation, the City argued that most of the Landowners inherited their interests when drilling was prohibited and never spent any money on drilling.   Landowners argued that a decision by the U.S. Supreme Court held that a court cannot consider existing regulations when property is acquired in evaluating investment-backed expectations.   The court rejected this argument, construing the U.S. Supreme Court opinion’s consideration of time-of-conveyance regulations as limited to a ripeness analysis.  Because the ordinance in this case had already been found ripe in previous litigation, the court primarily relied on the fact that Landowners inherited their interests when drilling was restricted.   The court also rejected Landowners’ argument that because extraction is the only use of minerals, the investment-backed expectations factor should not apply.  The court reasoned that the purpose of the factor was to assess whether a landowner took “legitimate risks with the reasonable expectation of being able to use the property, which, in fairness and justice, would entitle him or her to compensation.  This is true regardless of the nature of the property interest owned.”   Therefore, the second factor also weighed heavily in favor of the City.   The evidence showed that the existing wells had continued to produce, and there was no evidence of investments made with the expectation that new wells would be drilled.
Finally, on the third factor, the court acknowledged that the ordinance had a “fairly significant economic impact” on Landowners.   However, in conducting the balancing test, the court found that the first two factors outweighed the third, and there was no compensable taking.  “With substantial government interests at stake and minimal-to-no investment-backed expectations, justice and fairness do not require compensation in this case.”   One justice dissented, stating that Landowners could recover under a damage theory even if the taking theory was foreclosed.
This case is significant because drilling restrictions that limit or prohibit extraction can easily make the mineral estate worthless.  With the expansion of the urban environment and the risk of more limitations on drilling and production techniques, such as fracking, mineral owners could see public concerns trump their private right to extract minerals, with the government not obligated to pay for the regulatory taking.