KiefaberOliva

Double Tax Trouble: Cross-Conveyances and Ad Valorem Tax Liability When Pooling Across County Lines

March 3, 2021 In two companion cases, Chambers v. San Augustine Cnty. Appraisal District[1] (“Chambers I”), and San Augustine Cty. Appraisal District v. Chambers[2] (“Chambers II”), the Tyler Court of Appeals was tasked with determining the effect of mineral interest pooling across county lines on ad valorem tax liability.

Oliver Lane Chambers, et al. (the “Chambers”) own 652 acres of land in Shelby County, Texas.  In 2007, the Chambers entered into various oil and gas leases that were later pooled into two production units that also included lands in San Augustine County.  In 2013, the San Augustine County Appraisal District (“SCAD”) sent the Chambers notice of an appraised value for their fractional royalty interests in the two units.  The Chambers duly filed a notice of protest asserting that SCAD did not have authority to tax their mineral interests because their interests were located and properly taxed in Shelby County. When the SCAD review board declined to withdraw its appraisal, the Chambers filed suit in the San Augustine County District Court.[3]

In Chambers I, the plaintiffs requested that their mineral interest be removed from the SCAD tax roll.  However, the trial court held that the Chambers had “cross-conveyed their mineral interests with other mineral owners, and [that they were] appropriately taxed in both San Augustine and Shelby Counties in proportion to the percentage of the unit lying within each county.” [4] On appeal, the Chambers conceded that their mineral interests were pooled into the two units but that their leases expressly prevented a cross-conveyance of interest.  The Chambers also attempted to argue that SCAD had no authority under any circumstances to tax an interest located exclusively in Shelby County.[5]

Generally speaking, an appraisal district only has authority to tax property that lies within its boundaries, and the boundaries of a tax appraisal district are the same as the boundaries of its county.  Tex. Tax Code Ann. § 6.02(a); see Oak v. Collin Cty., 692 S.W.2d 454, 455 (Tex. 1985).  However, when oil and gas interests are pooled in Texas, it ordinarily creates the presumption of a “cross-conveyance” of interests.  This means that all the parties subject to a pooling agreement own an undivided interest in the pooled mineral interests in proportion their acreage contribution bears to the entire unitized area.  Production anywhere on a pooled unit is treated as production on every tract in the pooled unit, and all royalty owners share in unit production regardless of where a well is drilled.[6]  Thus, in many instances when a properly pooled and cross-conveyed unit straddles two counties, all royalty owners in the unit will owe ad valorem taxes in both counties in the proportion that the pooled lands lie within each county.[7]

Here, the Chambers’ leases contained language that authorized pooling, but expressly prevented a cross-conveyance of their interests.  Texas law has long upheld that parties may freely contract to include language in their leases that avoids cross-conveyancing.  Thus, lease language specifying that pooling shall not “exchange or transfer any interest” is a permissible express rejection of the cross-conveyance of interests.  Accordingly, the Tyler Court of Appeals in Chambers I held that the Chambers leases allowed pooling but prohibited a cross-conveyance of interests.  The Chambers thus had no obligation to pay taxes in San Augustine County.[8] The case was remanded to the San Augustine County District Court to proceed under these guidelines.

After the case was remanded, the trial court ruled that the Chambers’ royalty interests lie outside of SCAD’s boundaries, and that SCAD was not authorized to assess ad valorem taxes.[9]  This time SCAD appealed, arguing the affirmative defenses of waiver, ratification and estoppel.  SCAD’s arguments in Chambers II basically centered around the assertion that notwithstanding the language of the leases, by signing division orders and accepting royalty payments calculated on the basis of pooling, the Chambers were estopped from arguing that there had been no cross-conveyance.[10]

In response to SCAD’s arguments, the Chambers II Court provided a convenient comparison of the affirmative defenses of ratification, waiver, and quasi-estoppel.  Ratification occurs when a person who knows all the material facts confirms or adopts a prior act that did not then legally bind him.  To prove ratification, you must establish (1) approval by act, word, or conduct, (2) with full knowledge of the facts of the earlier act, and (3) with the intention of giving validity to the earlier act.[11] Waiver, on the other hand, is an intentional relinquishment of a known right or intentional conduct inconsistent with claiming that right.  Waiver cannot exist if the person allegedly waiving a right says or does nothing inconsistent with an intent to rely on the right.[12] Finally, quasi-estoppel precludes a person from asserting, to another’s disadvantage, a right inconsistent with a position previously taken.  It is an equitable doctrine that applies when it would be unconscionable to allow a person to maintain an inconsistent position.[13]

In applying the doctrines of ratification, waiver, and quasi-estoppel to the Chambers’ actions, the court found that none of these affirmative defenses gave SCAD the right to tax the Chambers’ Shelby County properties.  The execution of division orders did not, as SCAD argued, “subordinate and supersede” the express lease provisions disclaiming a cross-conveyance.[14] First, the division orders included the standard language that they “do not amend any lease . . . between the undersigned and the lessee . . .” Although signing a division order and accepting payment may have the effect of ratifying a pooled unit, the parties here were not contesting the pooling itself.  Rather, what was at issue in Chambers I and II was whether the pooling created a cross-conveyance under the terms of the leases.  Because a division order cannot alter the terms of a lease, the Chambers’ act of signing their division orders and accepting royalty payments calculated on the basis of pooling did not act as a ratification of cross-conveyance.  Thus, the court held that the Chambers did not ratify the cross-conveyance or waive their rights to assert the anti-cross-conveyancing language in their leases.  Further, the Chambers were not estopped (or quasi-estopped) from enforcing said anti-cross-conveyance language.  Finally, the Chambers II Court was unsympathetic to SCAD’s claim that its holding would “create uncertainty in every royalty payment” and taxing districts “would be forced to review every lease, many of which are not public record.”[15]

This case provides an interesting insight into the sometimes misunderstood effects of the cross-conveyancing theory in Texas (or in this situation, contracting around a cross-conveyance).  The Tyler Court of Appeals did not seem to be concerned about burdening an appraisal district with potentially having to investigate and construe the contents of a specific oil and gas lease.  At least in situations where a production unit straddles a county line, it appears that appraisal districts may now have a heightened duty to ascertain whether a true cross-conveyance was effectuated under the terms of a lease before appraising ad valorem taxes on royalty payments.  One takeaway might be that depending on the property tax rates in two adjacent counties, it may behoove lessors whose property lies on or near the county line to include an anti-cross-conveyancing clause in their leases.

Ultimately, the Chambers II Court held that signing a division order does not have the effect of ratifying a cross-conveyance of interests and that the Chambers were entitled to rely upon their lease language which prohibited cross-conveyancing.[16]  As a result, the Court of Appeals affirmed the trial court’s judgment that SCAD failed to establish authority to tax the Chambers’ mineral interests.

__________________________________________________________________________

[1] 514 S.W.3d 420 (Tex.App.—Tyler 2017, no pet.).

[2] 618 S.W.3d 398 (Tex.App.—Tyler 2021, pet. denied).

[3] 514 S.W.3d 420, 422.

[4] Id. at 423.  It is worth noting here that this would be a proper method of assessing ad valorem taxes in many circumstances.

[5] Id.

[6] Id. at 423-4.

[7] Id. at 425 (“SCAD failed to establish that [the Chambers] owned an interest in pooled minerals located in San Augustine County, and thus had an obligation to pay taxes in that county.”)

[8] Id.

[9] 618 S.W.3d 398 (Tex.App.—Tyler 2021, pet. denied).

[10] Id. at 401.

[11] Id. at 402.

[12] Id.

[13] Id.

[14] Id.

[15] Id. at 403 (“SCAD can tax minerals outside San Augustine County when cross-conveyance theory is properly applied.  No Texas statute provides for taxation of minerals outside the boundaries of the taxing unit merely by virtue of the fact that they are included in a production unit pursuant to a pooling agreement.  No statute provides that pooing results in a cross-conveyance.  [The Chambers’] leases prohibit cross-conveyance of interests.  SCAD is required to apply the law, even if it means adapting as the applicable law is clarified through the judicial process.”).

[16] The Court also noted that this holding is consistent with Texas statutory law.  “No Texas statute provides for taxation of minerals outside the boundaries of the taxing unit merely by virtue of the fact that they are included in a production unit pursuant to a pooling agreement.  No statute provides that pooling results in a cross-conveyance.”  Id. at *11.

__________________________________________________________________________

CONTACT

If you have any questions regarding this case law update or suggestions for topics to be covered in future issues, please call our office at 713-229-0360 or contact:

Brad Gibbs

Partner, Houston

[email protected]

Eli Kiefaber

Partner, Houston

[email protected]

Zachary Oliva

Partner, Houston

[email protected]

The content of this publication and any attachments are not intended to be and should not be relied upon as legal advice or to create a lawyer-client relationship.

© 2022 Kiefaber & Oliva LLP. All rights reserved. This publication may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Houston (principal office): 815 Walker St., Suite 1140, Houston, Texas 77002, 713-229-0360 | Columbus: One East Livingston Avenue, Suite B, Columbus, Ohio 43215, 614-349-4525.

SHARE
FOLLOW