Texas Supreme Court Clarifies Scope of Duty Owed by Executive Rights Holder to Holder of Non-Participating Royalty Interests

On March 6, 2015, the Texas Supreme Court issued its opinion in the KCM Financial LLC et al. v. Bradshaw case regarding duties owed by the holders of executive rights to the owners of non-participating royalty interests.

Bradshaw inherited non-participating royalty interests for property located in Hood County, Texas. Steadfast owned the surface, a portion of the mineral interests and the executive rights which gave Steadfast the right to enter into oil and gas leases and collect and retain any bonuses. Steadfast leased the minerals in 2006 to Range Resources and also sold the surface to Range. Under the terms of the lease, Steadfast received a lease bonus of over $7,500 per acre but only reserved a 1/8 royalty. Because Bradshaw only held a non-participating royalty interest, she was not entitled to share in the bonus but would receive a share of the 1/8 royalty reserved in the lease.

Bradshaw sued claiming that Steadfast had breached its duties to her as holder of the executive rights. Bradshaw claimed that the market rate for royalty at the time of the lease was 1/4, not 1/8. Bradshaw alleged that Steadfast engaged in self-dealing by obtaining a large bonus payment at the expense the royalty.

The Texas Supreme Court held that Bradshaw stated potential claims against Steadfast for breach if its duties as the executive and remanded the case to the trial court for jury trial. The Court reiterated that an executive owes a duty of utmost good faith and fair dealing to a non-executive and cannot engage in self-dealing when entering into an oil and gas lease. This duty does not mean that the executive must always put the interests of the non-executive above its own – however, the duty does prevent the executive from self-dealing and diminishing the value of the non-executive’s interest. The Court concluded that Steadfast’s failure to obtain a market rate royalty did not establish a breach of duty as a matter of law, but could constitute evidence at trial of Steadfast’s failure to fulfill its duty. Therefore, the Court remanded the case back to the trial court for jury trial.

This case again illustrates the important duty of utmost good faith and fair dealing that executive rights holders owe to the non-executives (such as holders of non-participating royalty interest owners) when negotiating lease terms. Executives must avoid engaging in self-dealing to the expense of the non-executive.

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