The Texas Supreme Court recently reaffirmed the longstanding principle that an executive rights holder owes a duty of utmost good faith and fair dealing to a non-executive and is prohibited from engaging in self-dealing in connection with the formation of a mineral-lease agreement. KCM Financial LLC v. Bradshaw, No. 13-0199, 2015 Tex. LEXIS 220, __ S.W.3d __ (Tex. Mar. 6, 2015). The Court, however, also explained that the executive is not required to wholly subordinate its interests in favor of the non-executive, and that the executive has autonomy and considerable latitude in negotiating the terms of a mineral lease (just not unbridled discretion). Given the relative rights and interests at play, the Court declined to issue any bright line rules regarding the scope of the duty of utmost good faith and fair dealing. Rather, the Court stated that “in determining whether an executive has fulfilled its duty of utmost good faith and fair dealing in executing a mineral lease, the lease and the circumstances of its execution must be considered as a whole.” The controlling inquiry is whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.
In KCM Financial, the non-executive complained that the executive breached its duty by executing a mineral lease on terms that included a sub-market royalty rate, which the executive and non-executive would share equally, in exchange for an above-market bonus payable only to the executive. The non-executive also alleged that the lessee acted in concert with the executive in facilitating the breach. The executive and lessee won on summary judgment at trial.
The Supreme Court, however, held that, given the totality of the circumstances in this case, the lessor’s negotiation of an above-market bonus (for itself) and below-market royalty (shared with the non-executive) may give rise to liability to the non-executive. In other words, the executive’s failure to obtain a market-rate royalty does not conclusively establish a breach of duty, nor is it totally irrelevant – it is simply one factor to be considered. Thus, the Court determined that fact issues precluded summary judgment for the executive and remanded that portion of the case back to the trial court to be tried.
As to the lessee, the Court determined that it was entitled to summary judgment because the lessor’s alleged breach of its duty to the non-executive could not be imputed to the lessee as a matter of law under any conspiracy and aiding-and-abetting theories, noting the considerable burdens that a contrary holding would impose on the energy industry in Texas.
This client alert was authored by Gardere Partner James C. (Jim) Scott. For additional information regarding the Texas Supreme Court's opinion, please contact Mr. Scott ([email protected] or 214.999.4598) or another member of Gardere's Energy Industry Team.