Big Oil v. Royalty Owners

Who said Big Oil can't beat Texas royalty owners?

Not Blawgletter. And definitely not the Supreme Court of the Lone Star State.

Royalty owners typically become that by granting your ExxonMobils, your Conocos, your BPs, and the like the right to drill for oil and gas. The lease contract calls for the lessor (mineral owner) to get royalties on any production from good wells (plus per-acre "bonus" payments on the front-end no matter what). And the royalties usually equal a fraction (e.g., one-eighth) of what the lessees sell any oil and gas for.

Victory for Exploration and Production Companies

A couple weeks ago, the Court handed Shell Oil Company, and its Big Oil brethren, a huge win against Texas royalty owners. Although Shell admitted that it underpaid mineral owners in the Permian Basin, the Rosses, around $73,000 from 1988 through early 1994, the Court ruled for Shell — unanimously.

Shell asserted as its main defense that the Rosses had waited too long to sue. A Houston jury disagreed, finding that Shell defrauded the family by sending them royalty checks that understated the prices at which Shell sold the Rosses' gas. The trial court entered judgment on the verdict.

The court of appeals affirmed. But the Supreme Court held that the evidence proved, as a matter of law, that the Rosses hadn't used "due diligence" to figure out that Shell had short-paid them on the royalties.

Texas Two-Step

The Court used a two-step analysis. It first ruled that the Rosses should have noticed that royalty check stubs that Shell sent them showed different prices for gas from the same reservoir. One set of check stubs — for the Rosses' "Lease Wells" — reflected prices far less than those on other check stubs — for the "Unit Wells", which Shell had drilled on land near the Rosses'. "The large difference in the prices paid to the Rosses on the Unit Wells and on the Lease Wells", the Court said, "triggered the Rosses' duty to investigate the royalty payments." Shell Oil Co. v. Ross, No. 10-0429, slip op. at 7 (Tex. Dec. 16, 2011).

Step two dealt with what the Ross family should have done once the "duty to investigate" arose. The Court noted that the Rosses could've looked at "readily accessibly and publicly available information" to see that prices on the Shell check stub prices fell below market prices. The info consisted of records at the Texas General Land Office — a state agency that received (higher) royalty payments for its share of the gas under a "pooling and unitization agreement" with the Rosses — and an index of gas sales prices in the Permian Basin. The combination of a duty to investigate and the fact that an investigation "could have led to discovery of Shell's underpayments" established Shell's limitations defense as a matter of law, the Court held. Id. at 9 (emphasis ours).

Check Those Check Stubs

What does the outcome mean for royalty owners? Mainly it suggests that they can't rely on oil companies to report accurately and must instead look for signs of perfidy. Also that, once red flags "trigger[] the . . . duty to investigate the royalty payments", royalty owners must consult public data to see if it supports the view that the lessee has short-paid royalties. Even if you have to go to Austin to examine the General Land Office's records.

Note that the Court requires royalty owners to assume the worst. The fact that the prices for the Unit Wells far exceeded the prices for the Lease Wells didn't trigger a duty to look only into the Lease Wells prices but also into the (much higher) prices for the Unit Wells. (Really? Why?) And the Court didn't require that a review of public records "would" lead to discovery of underpayments. It instead called for a "could" test. (Huh? Surely the public info needs to show a clear case of underpayment for a court to take the issue from a jury. "Could" strikes us as far too lenient for the short-payers.)

Landowners of Texas, get out your royalty check stubs and start looking for discrepancies. And do it now. The clock may have started ticking.