A New Day for Louisiana Oil and Gas Lenders?
jdsupra.com August 29, 2017
Lenders to Louisiana operators are likely to be reconsidering their business practices in light of Gloria’s Ranch v. Tauren et al.
A rather ordinary lease termination suit resulted in the lender Wells Fargo being solidarily liable with the lessees for $22.8 million in lost leasing opportunities, $242,000 in unpaid royalties, $484,000 in statutory damages, and almost $1 million in attorneys’ fees.
Wells was solidarily liable with the lessees because:
The lease was on 1,390 acres in Caddo Parish. The deep rights were owned 51 percent by Exco (who settled before trial) and 49 percent by Cubic. The shallow rights were owned 51 percent by Tauren and 49 percent by Cubic. Wells Fargo’s credit facility and mortgage were converted into a net profits interest in a portion of the shallow rights and an override in a portion of the deep rights. The lessees were counting on several Cotton Valley wells to hold the lease.
Mineral Code Article 124 requires production in paying quantities: Would a reasonable prudent operator, for the purpose of making a profit or minimizing loss, continue to operate a well in the manner in which the well in question was operated?
After a bench trial the court found:
Penalty for unpaid royalties: Times two or plus two?
Plus two. Under Mineral Code Art. 140 if the lessee fails to pay royalties or to inform the lessee of a reasonable cause for failure to pay, the court may award as damages “double the amount of royalties due”. Is that unpaid royalties times two or plus two? The court concluded that statute means the offending lessee must pay unpaid royalties plus 2 times the royalties.
The dissent, respectful but … indignant?
Two justices were unhappy with the result. Justice Brown predicted an apocalypse of sorts for Louisiana’s oil business. Justice Bleich agreed, contending it was legal error to impose solidary liability on a mortgagee with only a security interest. Solidary liability is never presumed and arises only from a clear expression of the parties’ intent or by law. In the name of public policy alone, this aberration needs to be corrected.
I agree that the potential collateral damage could be extensive however Wells Fargo should have performed some due diligence in regard to Tauren/Cubic before providing the mortgage commitment. What is unclear is whether Wells Fargo understood the ramifications of the regulatory statutes and decided to withhold consent to release the lease. Considering the recently revealed business practices of Wells that could have been their call. Regardless of any prior recognition of potential consequences, when you lie down with dogs you get fleas.
The Haynesville Shale boom created numerous situations where these facts apply.
After a bench trial the court found:
The Louisiana Supreme Court’s reversal of Gloria’s Ranch, L.L.C. v. Tauren Exploration, Inc., hands a victory to financiers of oil and gas operations and settles a long-running controversy over the amount of damages available for failure to pay mineral royalties.
The Gloria’s Ranch trial court held two mineral lessees and a mortgagee (Wells Fargo) solidarily liable for more than $20 million in damages resulting from failure to release a mineral lease in North Louisiana. The Second Circuit affirmed the finding of solidarity on the basis that Wells Fargo became an owner of the mineral lease because it “controlled the bundle of rights that make up ownership, i.e., the rights to use, enjoy, and dispose of the lease.” However, a vigorous dissent warned that the majority’s “control theory” to impose solidarity between a mortgagee and a mineral lessee could have “[d]evastating economic repercussions” for the lending industry, and “[s]erious and harmful impact on the oil and gas industry.”
A mortgagee with a security interest in a mineral lease can’t be held liable for breaches of the lease
In an opinion released June 27, 2018, the Louisiana Supreme Court reversed the finding that Wells Fargo was liable with the mineral lessees for the failure to release the mineral lease under Mineral Code articles 206 and 207. Those articles set forth the obligations of the “former owner” or “former lessee” to provide written evidence that mineral rights have been extinguished. The Court held, however, that Wells Fargo was merely a creditor with a security interest in a mineral lease, and not an “owner.”
The Court rejected the contention that Wells Fargo’s “rights of control” under its mortgage and credit agreement to direct aspects of mineral lease operations and to receive profits from the lease conferred ownership. Instead, the Court found these “provisions typical of security contracts, all designed to protect the collateral.” The Court also observed that “none of the provisions of the mortgage or credit agreement convey to Wells Fargo the right to explore for and produce minerals on the property—the primary right granted in a mineral lease and the stamp of ownership thereof.”
“Double” isn’t Treble
Gloria’s Ranch also brought a claim for unpaid royalties under Mineral Code article 140, which states in pertinent part:
If the lessee fails to pay royalties due or fails to inform the lessor of a reasonable cause for failure to pay in response to the required notice, the court may award as damages double the amount of royalties due[.]
The lower courts awarded Gloria’s Ranch $726,087.78 in damages: $242,029.26 in unpaid royalties, plus an additional double damages penalty of $484,058.52. This calculation interprets the “double damages” provision of article 140 to mean the amount of royalties due plus an additional penalty of two times the amount of royalties due—effectively awarding treble damages.
The double versus treble interpretation of article 140 has long been a source of dispute, with no clear appellate court guidance to date. The Supreme Court ended the uncertainty in its opinion, when the majority of the Court found the lower courts’ calculation to be wrong. Settling the interpretive dispute, the Court held that the language of article 140 is “a clear authorization by the legislature for courts to award a maximum of two times the amount of unpaid royalties, not three times the amount.” Because “damages” are compensation for a loss, they must necessarily include the amount owed. The Court reasoned:
Clearly, an award of the amount of royalties due is the compensation for the failure to perform that obligation. The use of the permissive word “may” gives the court the authority to double that amount if the court, in its discretion, finds the defendant’s conduct so warrants. A contrary reading that assumes the unpaid royalties are something separate from “damages” ignores the plain meaning of the word “damages.”
Justice Genovese dissented from this holding.
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Good decision. As I said above at the time, Judge Joe Bleich had it right in his dissent.
I thought you would appreciate the reversal. Being the only other person in this discussion thread. :-)
This is a significant victory in lessees / operators in LA continuing to be able to gain access to financing for operations in which lease and well assets are pledged as collateral, as well as lenders in deflecting potential liability to such judgments in merely holding a security interest in working interest / leasehold. The original trial court and appellate rulings, in the opinion of a dissenting judge, had created a “chilling environment” for such financing if the prior rulings were allowed to stand. It appears that this miscarriage has been averted.
I found it important in reading the prior opinions that weight had been given less as to Wells Fargo's security interest and more to its activity in "managing" the lease and operations. In most cases, lenders do not attempt to institute quite the level of control that WF did in this case. Certainly this can be attributable in part to the distressed financial position of the working interest owner and its relationship with Wells Fargo in its attempt to take a decidedly more active role in preserving the secured leases and assets. IMHO (IANAL) the lower courts weighed this in particular in its findings of fact. A more passive lender likely would have not had the level of exposure to such allegations.
My two cents.
Thanks for joining us William. Now there are 3 of us in this discussion thread. I can't for the life of me figure why Keith decided to "feature" it. :-)
I think he included it because it is interesting. No telling what other states are going though. I live Texas and as you know oil companies run wild. Takes a while but Texas finally catches up. Ran Chesapeake out of the Barnett Shale. CHK got sued by everybody regarding their handling of royalties. CHK finally settled all the suits and bailed out of Northeast Texas.
this case is very important. The facts were unusual - a large national bank taking an overriding royalty, etc, instead of just taking a mortgage on the leases and wells, along with the assignment of interest in the event of default. Some loan officer at Wells Fargo got a little too creative. But the case is important because the plaintiffs thought that they had found the ultimate deep pocket for their loss. Don't get me wrong, I'm not here suggesting that the operator has clean hands. Far from it. But it would be a truly terrible precedent if the Court had allowed the judgment against Wells Fargo to stand. Funding for small to mid-sized operators could have been seriously impacted.
The operator in question is ethically challenged. Wells Fargo picked the wrong partner. They probably short cut the due diligence. And dodged a bullet.