The Ins & Outs of Nonparticipating Royalty Interests Ins _ Outs of... · • Distinction from Temple Inland Forest Products Corp. v. Henderson Family P’ship, Ltd. (“1/16th part

The Ins & Outs of Nonparticipating Royalty Interests

Texas and Oklahoma Series

Sarah Trainer & Andrew Graham

Andrew S. Graham

Member

(304) 598-8161

[email protected]

Sarah G. Trainer

Associate

(281) 203-5775

[email protected]

2020 Texas and Oklahoma Webcast Series

Today’s Topics• How to distinguish a nonparticipating royalty

interest (NPRI) from a mineral interest

• Fixed v. Floating NPRIs

• What powers (and responsibilities) does the holder of the executive right have to grant an OGL subject to an NPRI

• When and how can NPRIs be pooled into units

• How are NPRIs treated in allocation wells


DISTINGUISHING NPRIS FROM MINERAL INTERESTS


What is a Nonparticipating Royalty Interest?

• A royalty interest carved from the mineral estate.

• An interest in land that has no right of possession or use – justthe right to receive a royalty.

• Owner has no right to lease and receives no bonus or delayrentals when the land is leased.

• Created by a grant or reservation and in perpetuity or for a term.


• Right to ratify the pooling clause of an oil and gas lease covering the land in which the NPRI owner has an interest.

• Right to ratify a pooled unit which includes an oil and gas lease covering the land in which the NPRI owner has an interest.

• No right to execute oil and gas leases covering their interest.

• Not bound by a pooling clause in a lease which the NPRI owner did not execute or ratify.

Rights of NPRI Holders - TX


The Mineral/Royalty Puzzle

• Early form deeds ambiguously purport to convey either a mineral interest or a royalty interest.

• These deeds have caused confusion and misinterpretation of the resulting interest.

• Deeds that convey a royalty interest leave the question as to whether that interest is a fixed or floating royalty.

• How do you know what interest is being conveyed or reserved?


Elements of Mineral Ownership

• Right to develop (cost bearing)

• Right to lease

• Right to receive bonus payments

• Rights to receive delay rentals

• Rights to royalty payments

• French v. Chevron U.S.A. Inc., 896 S.W.2d 795, 797 (Tex. 1995),Schlittler v. Smith, 101 S.W.2d 543, 544 (Tex. 1937), Altman v. Blake, 712 S.W.2d 117, 118 (Tex. 1986).


Mineral or Royalty?

• A grant is likely to be a mineral if:

– The deed uses the term “mineral.”

– The grant is a fraction of oil and gas “under the land.”

– The grant is a fraction of oil and gas “in, under, and that may be produced from the land.”

– The grantee’s interest is cost bearing (profit sharing) and includes the right to lease and receive bonus and rentals in addition to receiving royalty.


Mineral or Royalty?

• A grant of an interest is likely a royalty if:

– The deed uses the term “royalty.”

– The grant is a fraction of oil and gas “produced and saved and marketed.”

– “Cost free” language is included.

– The Grantee does not receive any attributes of the mineral estate such as the right to lease, the right to receive bonuses, or the right to delay rental. See French v. Chevron, 896 S.W.2d 795 (Tex. 1995).


Mineral or Royalty? How did the Courts Rule?

• “Grantor retains title to a 1/16 interest in and to all of the oil, gas and other minerals in and under and that may be produced from said land; but it is distinctly agreed and understood that the grantor shall not receive any part of the money rental paid on any future lease; and the grantee shall have authority to lease said land and receive the cash bonus and rental; and the grantor shall receive the royalty retained herein only from actual production of oil, gas or other minerals on said land.”- Watkins v. Slaughter, 189 S.W.2d 699 (Tex. 1945) (emphasis added)

Holding: This recital reserved a 1/16 royalty interest.

– Court focused on the royalty label and the recital that said royalty would come from “actual production.”

– Takeaway - the power of the royalty label to overcome the standard mineral label when present, as well as the weight the court gives to each clause of the reservation.


Mineral or Royalty? How did the Courts Rule?

• “Grantor does hereby grant…unto…Grantee an undivided 1/16 interest in and to all of the oil, gas and other minerals in and under and that may be produced…. But does not participate in any rentals or leases, containing 348 acres, more or less, together with the rights of ingress and egress at all times for the purpose of mining, drilling, exploring, operating, and developing.” - Altman v. Blake, 712 S. W. 2d 117 (Tex. 1986) (emphasis added).

Holding: This recital conveyed a 1/16 mineral interest.

– The reservation of the rights to receive a bonus and delay rentals is not inconsistent with the conveyance of a mineral interest and does not relegate the interest conveyed to a mere royalty interest.

– Takeaway - if intent was to convey only royalty, mentioning leasing, rental, and bonus rights would have been redundant.


Mineral or Royalty? How did the Courts Rule?• I [Grantor] do convey unto [Grantee] an undivided fifty (50) acre interest, being an undivided

1/656.17th interest in and to all of the oil, gas and other minerals, in, under and that may be produced …. It is understood and agreed that this conveyance is a royalty interest only, and that neither the Grantee, nor his heirs or assigns shall ever have any interest in the delay or other rentals or any revenues or monies received or derived from the leasing of said lands present or future…Neither the Grantee herein nor his heirs or assigns shall ever have any control over the leasing…which is hereby specifically reserved.” – French v. Chevron U.S.A. Inc. 896 S.W. 2d 795 (Tex. 1995) (emphasis added).

Holding: This recital conveyed a 1/656.17 mineral interest.

– The Court considered the clause’s stripping away mineral attributes as better describing the type of mineral interest- one without any of the attributes of a mineral interest other than a percentage of lessor royalty.

– Takeaway - when trying to describe a royalty interest, describe it accurately once and do not attempt to further describe the interest by reference to what it is not.

• Distinction from Temple Inland Forest Products Corp. v. Henderson Family P’ship, Ltd. (“1/16th part and interest in the oil, gas and other minerals…always a royalty and not charged with [any costs]”). Court held this was a royalty because of the cost-free language.


Fixed v. Floating Nonparticipating Royalty

• Once you determine you have a nonparticipating royalty, a more common problem is determining if the resulting interest purports to convey/reserve a “fixed” royalty or a “floating” royalty.

• A “fixed” or “fractional” royalty- entitles the owner to the specified fractional amount stated in the deed and remains constant regardless of the amount of royalty contained in a subsequently negotiated oil and gas lease.

– Independent of the size of royalty provided in the lease.

• A “floating” or “fraction of” royalty is a fraction of the royalty provided in the lease, whatever that may be. This type of royalty is multiplied by the lessor’s royalty provided in the lease and therefore, can fluctuate from lease to lease.


Examples of Fixed Royalty

• An undivided 1/16th royalty interest;

• A 1/4 royalty in all minerals in and under and hereafter produced;

• One-half of the one-eighth royalty interest;

• An undivided 1/24 of all of the minerals produced, saved, and made available for market;

• 1% royalty of all of the oil and gas produced and saved.– See Leal v. Cuanto Antes Mejor LLC, No. 04-14-00694-CV, 2015 WL

3999034, at 3-4 (Tex. App. – San Antonio, Jul. 1, 2015, no pet.)


Examples of Floating Royalty

• 1/16 of all royalty;

• One-half interest in all royalties received from any oil and gas leases;

• An undivided one-half interest in and to all of the royalty;

• One-half of one-eighth of the oil, gas and other mineral royalty that may be produced;

• One-half of the usual one-eighth royalty.– See Leal v. Cuanto Antes Mejor LLC, No. 04-14-00694-CV, 2015 WL

3999034, at 3-4 (Tex. App. – San Antonio, Jul. 1, 2015, no pet.)


The Practical Difference

• Gavenda v. Strata Energy, Inc., 705 S.W.2d 690 (Tex. 1986) (1/2 NPRI)

• Fixed royalty interest:

– “an undivided 1/16th royalty interest”

– Grantee receives 6.25% (1/16th of production)

• Floating royalty interest:

– “1/16th of all royalty” (ex. 1/8 RI)

– Grantee receives 0.78125% (1/16th of 1/8th lessor royalty)


Oklahoma Caveats

• In Oklahoma, the term “royalty” is treated as being uncertain in meaning. A grant of a royalty interest made at a time when no lease is in existence will be generally construed as creating a mineral interest. Melton v. Sneed, 109 P.2d 509 (Okla. 1940).

• If a lease is in existence or has even expired, the grant or reservation of a royalty is, generally, construed as a nonparticipating royalty interest. Colonial Royalties Co. v. Keener, 266 P.2d 467 (Okla. 1953).

• If the royalty interest being conveyed is unusually large (i.e., more than a 1/4), a court may interpret the interest as creating a mineral interest and not a royalty interest.


DUTIES AND OBLIGATIONS OF EXECUTIVE HOLDER


Duties and Obligations

• Executive holder is bound by duty of “utmost good faith”– Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984)

• Executive holder mortgaged minerals and then granted himself OGL with very favorable terms:

– $5 bonus for 25,911.62 acres

– Took 100% of 7/8 from three producing wells

– F/O: executive took 50% working interest, free of costs

• Court cancelled OGL for breach of executive’s duty



• Executive does not breach duty merely by not leasing minerals– In re Bass, 113 S.W.3d 375 (Tex. 2003)

• Breach only occurs if executive executes OGL and fails to obtain for non-executive owners the same benefits executive obtained

– Hlavinka v. Hancock, 116 S.W.3d 412 (Tex. App.—Corpus Christi 2003)

• No liability for failure to lease where several companies made offers and executive responded with counter-offers that were rejected by the companies



• Executive’s duty is breached if refusal to lease is arbitrary or motivated by self-dealing

– Lesley v. Veterans Land Bd., 352 S.W.3d 479 (Tex. 2011)

• Developer held executive right for land that had been divided into subdivision lots, subject to nonexecutive interest

• Developer burdened lots with restrictive covenant that prohibited mineral development

• Court cancelled restrictive covenants



• What if executive holder discovers land is being drained? – Federal Land Bank of Houston v. U.S., 168 F. Supp.

788 (Ct. Cl. 1958)

– Hawkins v. Twin Montana, Inc., 810 S.W.2d 441 (Tex. App.—Fort Worth 1991)

– Hudgins v. Lincoln Nat’l Life Ins. Co., 144 F. Supp. 192 (E.D. Tex. 1956)



• What if NPRI is term-limited and executive refuses to lease until after term has expired? – Kimsey v. Fore, 593 S.W.2d 107 (Tex. Civ. App.—

Beaumont 1979)• Affirmed jury award of damages to term royalty owner

– Pickens v. Hope, 764 S.W.2d 256 (Tex. App.—San Antonio 1988)

• Executive doesn’t owe fiduciary duty to royalty owner


Duties and obligations

• What if executive holder also owns the surface and takes large cash payments and payments out of production for “surface damages”? – Portwood v. Buckalew, 521 S.W.2d 904 (Tex. Civ. App.—Tyler

1975)

• What if surface owner/executive holder refuses to lease, but gives permission for seismic operations and is paid surface damages?– Hlavinka v. Hancock, 116 S.W.3d 412 (Tex. App.—Corpus

Christi 2003)



• What if executive holder doesn’t lease, but instead, enters into development agreement?

– Comanche Land & Cattle Co. v. Adams, 688 S.W.2d 914 (Tex. App.—Eastland 1985)


POOLING NPRIS


Pooling NPRIs

• Absent their consent, NPRI owners are not subject to the pooling provision in a lease

– Unless NPRI created subsequent to lease

– Mere reservation of an NPRI under a tract did not mean NPRI owner intended to give the executive rights owner the power to diminish their interest. Montgomery v. Rittersbacher, 424 S.W.2d 210 (Tex. 1968).

• In Oklahoma, a nonparticipating royalty interest may be force pooled, but it is not necessary because they do not participate in drilling. An operator only has to pool all parties with a right to drill.


Effect of Ratification

• Lessee pools tracts A and B

• NPRI owner ratifies the unit – entitled to royalty from well on either tract on surface acreage basis

• NPRI does NOT ratify – entitled to royalty from well on tract A –not diluted

BA1/16 NPRI


NPRIS AND ALLOCATION WELLS


NPRIs and Allocation Wells

• Allocation well: horizontal well drilled across multiple tracts without the formation of a pooled unit and without a production sharing formula among the owners of interests in the tracts traversed by the horizontal well

– If there were a production sharing agreement among the owners, then this would be a PSA well



• There has been a lively academic discussion about allocation wells: – Bret Wells, Allocation Wells, Unauthorized Pooling, and

the Lessor’s Remedies, 68 Baylor L. Rev. 1 (2016)

– Ernest E. Smith, Applying Familiar Concepts to New Technology: Under the Traditional Oil and Gas Lease, A Lessee Does Not Need Pooling Authority to Drill A Horizontal Well That Crosses Lease Lines, 12 Tex. J. Oil, Gas & Energy Law 1 (2017)



• Royalty in pooled unit is allocated on net surface acreage basis

• Browning Oil, Inc. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000)– Must allocate production with “reasonable probability”

• Springer Ranch, Ltd. v. Jones, 421 S.W.3d 273 (Tex. App.—San Antonio 2013)– Allocation made on take-point (or productive wellbore)

basis



BA1/16 NPRI


Disclaimer

These materials are public information and have been prepared solely foreducational purposes. These materials reflect only the personal views of theauthors and are not individualized legal advice. It is understood that eachcase is fact-specific, and that the appropriate solution in any case will vary.Therefore, these materials may or may not be relevant to any particularsituation. Thus, the authors and Steptoe & Johnson PLLC cannot be boundeither philosophically or as representatives of their various present andfuture clients to the comments expressed in these materials. Thepresentation of these materials does not establish any form of attorney-clientrelationship with the authors or Steptoe & Johnson PLLC. While everyattempt was made to ensure that these materials are accurate, errors oromissions may be contained therein, for which any liability is disclaimed.


Questions??


Summer Webcast SeriesJuly 15

Wills, Trusts, and Estates

Presenter: Kacie Bevers

July 22

Unrecorded Agreements and the Duty of Inquiry

Presenter: Melissa Munson

July 29

Return to Work - COVID-19 and OSHA

Presenter: Bill Wahoff

August 5

1099 Changes/Escheat

Presenter: Paula Rauchfuss


https://www.steptoe-johnson.com/kacie.bevers

https://www.steptoe-johnson.com/melissa.munson

https://www.steptoe-johnson.com/william.wahoff

https://www.steptoe-johnson.com/paula.rauchfuss

Documents

The Ins & Outs of Nonparticipating Royalty Interests Ins _ Outs of... · • Distinction from Temple Inland Forest Products Corp. v. Henderson Family P’ship, Ltd. (“1/16th part