Disclosures During Oil and Gas Lease Negotiations - Texas and Louisiana

The oil and gas industry has always been subject to booms and busts. Barnett Shale and Haynesville Shale lessors are recovering from their first “bust.” Their roller coaster ride started with oil and gas lease terms of $200/acre and a 1/8th royalty, up to $27,200/acre and a 1/4th royalty, and then back down to $500-$5,000/acre and a 1/5th royalty. In some cases, it seemed like the “going rates” changed overnight – sometimes dramatically.

Such dramatic swings in lease compensation have led to litigation from those who think they were defrauded into signing a lease for too cheap and are seeking to rescind the lease or obtain damages. A recent Louisiana case, Thomas v. Pride Oil & Gas Properties, Inc., illustrates this perfectly. Mr. Thomas owned 17 acres in Red River Parish, Louisiana, an area now widely known to be in the heart of the Haynesville Shale. In February 2007, before the Haynesville Sale “boom,” Mr. Thomas leased his minerals to Pride Oil & Gas Properties, Inc. for $100 an acre bonus and a 3/16th royalty. After news of the Haynesville Shale broke, lease prices soared to over $20,000 an acre bonus and a 1/4th royalty. Understandably, Mr. Thomas was not happy he had leased for such a small amount and he sued Pride to have the lease rescinded on multiple grounds, including fraud. Mr. Thomas’s fraud claim was on the ground that Pride allegedly knew about the Haynesville Shale and the true value of his lease but “took great steps to conceal the existence of the Haynesville Shale from the public.” The Court dismissed Mr. Thomas’s fraud claim on the grounds that Pride owed him no fiduciary duty to disclose information and Pride made no misrepresentations to Mr. Thomas during their negotiations. While the Thomas case worked out well for lessees, with slightly different facts, it could have gone the other way, resulting in a rescinded lease.

Given the amount of time and money invested in acquiring leases, parties need to know (i) the laws and rules governing negotiations, (ii) the possible consequences of breaking those laws and rules, and (iii) how to best negotiate to comply with the laws and rules.

The Laws and Rules Governing Lease Negotiations

Both Texas and Louisiana recognize that no fiduciary relationship exists between lessors and lessees. In laymen terms, this means that the parties have no duty to disclose information to the other side that might be relevant to the contemplated transaction. But, if a party makes a disclosure, either on its own or in response to a question or inquiry, the disclosure must not be false. Note that the law does not require a true answer; just that the answer not be false – giving a party the power to refuse to answer the question without violating the law.

Additionally, if individual seeking the lease is a member of American Association of Professional Landmen (“AAPL”) or an attorney, he or she is governed by professional codes of conduct and ethical responsibilities. Selected portions of the AAPL’s Code of Ethics and Standards of Practice, which govern the conduct of all AAPL members, provide as follows:

• It shall be the duty of the Land Professional at all times to promote and, in a fair and honest manner, represent the industry to the public at large with the view of establishing and maintaining goodwill between the industry and public and among industry parties. The Land Professional, in his dealings with landowners, industry parties, and others outside the industry, shall conduct himself in a manner consistent with fairness and honesty, such as to maintain the respect of the public.
• It is the duty of the land professional to protect the members of the public with whom he deals against fraud, misrepresentation, and unethical practices. He shall eliminate any practices which could be damaging to the public or bring discredit to the petroleum, mining, or environmental industries.
• The land professional shall at all times present an accurate representation in his advertising and disclosures to the public.

The American Bar Association’s Model Rules of Professional Conduct, from which all states’ base their respective attorney professional responsibility rules, provide, among other things, that in the course of representing a client a lawyer shall not knowingly make a false statement of material fact or law to a third person. AAPL members and lawyers also owe fiduciary duties to their respective employers and clients. This includes the fiduciary duty to not disclose confidential information.

Potential Consequences of Breaking these Rules of Negotiation

A party that makes a false representation or statement during the course of negotiating an oil and gas lease opens themselves and their employer or client up to a potential fraud claim. Such a claim could expose the offending party, and the offending party’s employer or principal, to actual and punitive damages or the lease being rescinded or reformed.

The Louisiana Civil Code provides that “fraud” is:

(i) a misrepresentation or suppression of the truth;
(ii) made with the intention either to
1. obtain an unjust advantage for one party or
2. to cause a loss or inconvenience to the other.
(iii) Fraud may also result from silence or inaction.”

Texas has two types of “fraud” for which the offending party may be liable. The elements of “common-law fraud” are:

(i) The defendant made a representation to the plaintiff;
(ii) The representation was material;
(iii) The representation was false;
(iv) When the defendant made the representation, the defendant
1. knew the representation was false, or
2. made the representation recklessly, as a positive assertion, and without knowledge of its truth;
(v) The defendant made the representation with the intent that the plaintiff act on it;
(vi) The Plaintiff relied on the representation; and
(vii) The representation caused the plaintiff injury.

And the elements for “statutory fraud” are:

(i) There was a transaction involving real estate or stock;
(ii) During the transaction, the defendant
1. made a false representation of fact,
2. made a false promise, or
3. benefited by not disclosing that a third party’s representation or promise was false;
(iii) The false representation or promise was made for the purpose of inducing the plaintiff to enter into a contract;
(iv) The plaintiff relied on the false representation or promise by entering into the contract; and
(v) The reliance caused the plaintiff injury.

If the offending party is a member of AAPL, the consequences could range from a minor reprimand from the group to being dismissed from the organization. And if the offending party is an attorney, the consequences could range from a minor reprimand from the State Bar Association to being disbarred and prohibited from practicing law. The attorney could also be subject to fines and a possible malpractice suit.

How Parties Should Interact with Each Other During Lease Negotiations

By way of example, assume a landman is taking leases in a new prospect that his company is very excited about but which the public is generally unaware. He has been instructed to only offer up to $500 an acre bonus and a 1/5th royalty even though he knows the lease is actually much more valuable and that royalties and bonuses will likely rise soon. The prospective lessor asks the landman if he thinks royalties and bonuses will soon increase. The honest answer is “yes,” the landman thinks royalties and bonuses will rise once word of this new prospect gets out. But, the landman’s obligations to his employer prevent him from giving this answer. And the law prevents him from giving a false answer. Therefore, he should give an answer like, “I really can’t comment on where royalties and bonuses may be heading. But I can tell you that this is the best offer I am authorized to give you today.” This answer contains no false statements and maintains his confidentiality responsibilities to his company.

In conclusion, lessors and lessees should take care how they negotiate leases. Lessors should not assume the landman will fully disclose all pertinent information. They should do their own research, ask the landman all questions they may have during the negotiations, and, if needed, consult an attorney; otherwise, the lessor risks signing a lease under less favorable terms than would have been otherwise available. And lessees need to carefully avoid making false statements while at the same time maintaining their employer or client’s confidences so as to not jeopardize the lease.

Eric C. Camp is an attorney in the law firm of Decker, Jones, McMackin, McClane, Hall & Bates, PC in Fort Worth, Texas. He is licensed in Texas and North Dakota and practices exclusively oil and gas law. Contact him at 817-336-2400 or ecamp@deckerjones.com.

Disclaimers

This article is not intended as legal advice and should not be relied upon as such. If you need legal advice, seek independent legal counsel.

These comments are the author’s own and not the official or unofficial position of any bar association. The author is an attorney licensed in Texas and North Dakota, not Louisiana.