The Duty of the Executive to Non-Executives

The Texas Supreme Court, in KCM Fin., LLC v. Bradshaw, No. 13-0199, 2015 Tex. LEXIS 220 (March 6, 2015), addressed the nature of the duty owed by the executive to the nonparticpating royalty owners or non-executive mineral interest owners and under what circumstances the executive has fulfilled its duty.  The Court described the duty owed by an executive as a duty of “utmost good faith and fair dealing,” but refused to create a bright line rule outlining the nature or boundaries of the executive’s duty.  Id., at *3-4.

The dispute in Bradshaw centered on the obligation of the executive to maximize the royalty terms in an oil and gas lease.  Betty Lou Bradshaw (“Bradshaw”) owned a one-half (1/2) non-participating royalty covering a portion of a 2,000 acre tract of land in Hood County, Texas, known as Mitchell Ranch.  Id., at *7.  Steadfast Financial LLC (“Steadfast”), which later changed its name to KCM Financial, LLC, is the owner of the executive right covering Bradshaw’s nonparticipating royalty interest and held the power to enter oil and gas leases covering the Mitchell Ranch.  Id., at *9,11.

On April 27, 2006, Steadfast executed an oil and gas lease to Range Resources covering the Mitchell Ranch and leased the mineral interest under Mitchell Ranch and reserved a one-eighth (1/8) royalty and received a lease bonus of $7,505 per acre.  Id., at *14.  As a result, Bradshaw was entitled to a one-sixteenth (1/16) non-participating royalty interest (one-half of the one-eighth royalty reserved in the mineral lease), but did not share in any part of the bonus obtained by Steadfast.  Id.  Bradshaw filed suit against Steadfast alleging that it, as executive, had violated its duty to her, as the non-executive interest holder, when it entered into the mineral lease with Range.  Id.  Bradshaw asserted that the one-eighth royalty negotiated between Steadfast and Range was below market value and that a one-fourth royalty had become standard in Hood County, Texas.  Id., at *15.  She also alleged that Steadfast engaged in self-dealing by obtaining a larger than usual bonus payment at the expense of securing a higher royalty.  Id.

The Texas Supreme Court has held that an executive owes a non-executive a duty of utmost good faith and fair dealing.  Id., at *2; Manges v. Guerra, 673 S.W.2d 180, 182-84 (Tex. 1984).  However, the relationship between the executive and the non-executive is unlike a fiduciary relationship, because the executive is not required to wholly subordinate its interest in favor of the non-executive if their interests conflict.  Id., at *2.  Rather, the executive’s duty is to “‘acquire for the non-executive every benefit that he exacts for himself.’”  Id., at *21 (quoting Manges, at 183-84).  Nevertheless, the Texas Supreme Court has held that the executive, as the party with the power to make and amend leases, has autonomy in negotiating the terms of a mineral lease, but that autonomy is limited by the scope of the duty to the non-executive.  Id., at *24; Manges, at 183.

In Bradshaw, the non-participating royalty interest was not a fixed interest, but rather was a fraction of whatever royalty was ultimately negotiated.  Id., at *15.  Because the executive’s duty is to acquire for the non-executive every benefit that he exacts for himself and because the executive is entitled to obtain more benefits under a lease that a non-executive is not entitled, such as bonuses and delay rentals, the Court held that all of the rights that comprise a mineral estate must be balanced to determine if each party obtained the same benefits.  Id., at *29.  Thus, even though Bradshaw and Steadfast obtained the same royalty interest under the lease entered into by Steadfast, Steadfast may still have breached its duty to Bradshaw.  Id., at *27.  The Court concluded that the failure to negotiate a market-rate royalty is only one of the factors to consider when evaluating whether the executive breached its duty to the non-executive.  Id.  Therefore, the entire subject transaction must be viewed as a whole in determining whether the terms of a mineral lease reflect the executive’s utmost good faith and fair dealing to the non-executive.  Id., at *32.

However, the Court held that if it was proven that Steadfast did in fact obtain a higher bonus in exchange for a lower than market-rate royalty interest, doing so with the intent to diminish the value of Bradshaw’s royalty interest, Steadfast would have violated its duty by engaging in self-dealing.  Id., at *30.  Nevertheless, as the case was only on appeal for determination as to whether summary judgment should be granted to Steadfast, the Court was only reviewing the evidence presented to determine if some evidence existed that Steadfast may have breached its duty to Bradshaw.  Id., at *32.  In conclusion, the Court held that some evidence did exist to support Bradshaw’s allegation that the mineral lease was the product of self-dealing on Steadfast’s part.  Id., at *34.  Therefore, Steadfast was not entitled to summary judgment.  Id.

Executive right holders should be aware when negotiating mineral leases whether a non-participating royalty interest may be subject to their negotiated lease.  If so, executive right holders should be mindful of the duty of upmost good faith and fair dealing they owe to the non-executive, while also trying to secure the best possible lease for him or herself.  Lessees and operators should be aware when negotiating with an executive that has a duty to nonexecutives and avoid giving the executive a higher bonus in exchange for  a below market royalty to avoid liability.  Although not before the Court in Bradshaw, Texas courts may hold lessees and operators liable along side an executive that breached its duty to a nonexecutive with the assistance of the lessee or operator.