005 Texas Oil & Gas Corp. v. Hagen

CASE OF THE MONTH

Richard F. Brown

 
The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
 
Texas Oil & Gas Corporation v. Hagen, S.W.2d , 31 Tex. S. Ct. J. 140 (December 19, 1987). Hagen owns royalty in gas units largely owned by and fully operated by Texas Oil & Gas Corporation (TXO). TXO sold the gas to its wholly-owned subsidiary, Delhi Gas Pipeline Corp. Hagen sued TXO to recover additional royalty based on TXO’s breach of the implied covenant to market the gas with good faith and reasonable diligence. The trial court found for Hagen and awarded over $1,000,000 in actual damages, $300,000 in exemplary damages, and $250,000 for attorneys’ fees. The breach of duty found by the trial court was centered upon TXO’s failure to retain the right to renegotiate the contract price if the market value of the gas escalated and upon TXO’s failure to retain the right to be paid royalties on sulphur. Obviously, TXO’s special relationship with Delhi was of some significance in the finding of a breach of duty.
 
The Supreme Court sustained the award of actual damages and attorneys’ fees, but reversed the award of exemplary damages. The interesting issues on appeal involved the definition of the duty owed by the lessee to the lessor for the performance of implied lease covenants and the remedy available for the breach of those covenants. The intermediate appellate court had described the duty as requiring the “highest good faith” and held that the lessor/lessee relationship “places the lessee in a position of trust and confidence.” The definition of the duty is significant because the breach of a fiduciary duty (as found by the intermediate appellate court) will support an award of exemplary damages. The Supreme Court rejected this heavy burden and held that the duty owed by the lessee to the lessor is that degree of care which would be exercised by a reasonably prudent operator under the same or similar circumstances:
 
[The standard of conduct of the lessee cannot be appropriately categorized as fiduciary . . . The relationship between the lessor and the lessee, absent evidence of some additional special relationship, is purely contractual, being created and governed by the lease document.
 
Because there is no fiduciary relationship, if no other independent or distinct tort is present, exemplary damages is not a remedy for breach of an implied lease covenant.
 
The case is significant because it establishes that lessors may not recover exemplary damages against lessees for breach of implied lease covenants. The decision apparently includes all implied tease covenants and is not limited to the implied covenant to market. The decision reduces the incentive to lessors to litigate breach of covenant cases, and it should be binding not only on future litigation, but also upon pending cases.