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Undivided Fractional Oil and Gas Interests – Part 2: Mineral or Royalty?

An issue often confronted by landmen and title examiners is whether or not an instrument creates a mineral or royalty interest. The answer to this question determines whether or not a lessee has obtained a valid lease, whether or not that lease covers all of the minerals, and what amounts should be paid to which parties under the lease. Unfortunately, the judicial landscape surrounding this question has been historically unreliable, with the Texas Supreme Court rendering inconsistent decisions as to the harmonization of conflicting deed clauses.

Texas law currently recognizes five elements that comprise ownership of the mineral estate, commonly referred to as the “bundle of sticks”. These include the rights to (i) execute a lease (executive right), (ii) develop the land (ingress/egress), (iii) receive bonus payments, (iv) receive delay rental payments, and (v) receive royalty payments. Altman v. Blake, 712 S.W.2d 117, 118 (Tex. 1986). The right to develop is considered correlative to and will generally pass with the executive right absent express language in the instrument. French v. Chevron U.S.A. Inc., 896 S.W.2d 795, 797 n.1 (Tex. 1995). Courts in Texas have looked both at commonly used descriptive phrases (labels) and the nature of the individual sticks in the bundle when interpreting instruments conveying or reserving undivided fractional interests.   

The most common mineral label refers to oil and gas “in and under” the lands. Absent other language in a deed, the conveyance of an undivided 1/2 of the oil and gas in and under Blackacre would effectively convey 1/2 of the mineral estate, with a corresponding 1/2 of each stick in the bundle. Two common royalty labels are the actual use of the word “royalty” and reference to the oil and gas “produced and saved” from the lands. The conveyance of and undivided 1/16 royalty interest in and to the oil and gas produced and saved from Blackacre would effectively convey a fixed 1/16 NPRI. Of course, in accordance with Murphy’s law, the deeds we encounter in practice are never as simple. What happens, for example, when the labels contradict each other?

The Texas Supreme Court revisited the issue of conflicting mineral and royalty labels in French v. Chevron U.S.A. Inc., 896 S.W.2d 795 (Tex. 1995).  The French decision, although contrary to its previous decision in Watkins v. Slaughter, 189 S.W.2d 699 (Tex.1945), provides an excellent teachable moment in how not to draft a mineral or royalty deed. 

In French, the Court was faced with the following contradictory paragraphs:

[I, Grantor] do grant…convey…unto [Grantee], an undivided Fifty (50) acre interest, being an undivided 1/656.17th interest in and to all of the oil, gas and other minerals, in, under and that may be produced from the following described lands. Id. at 796 (emphasis added).

It is understood and agreed that this conveyance is a royalty interest only, and that neither the Grantee, nor his heirs or assigns shall ever have any interest in the delay or other rentals or any revenues or monies received or derived from the leasing of said lands present or future…or the renewal or extension of any lease or leases now on said lands… Neither the Grantee herein nor his heirs or assigns shall ever have any control over the leasing…or the renewal or extending of any lease thereon or for the making of any lease contract to develop…which is hereby specifically reserved in the Grantor. Id. at 796 (emphasis added).

The first paragraph of the French Deed contains a mineral label (“in, under and that may be produced”), followed by a conflicting second paragraph containing what seems like a fairly strong royalty label (“this conveyance is a royalty interest only“), and a subsequent stripping of the entire bundle of sticks except the right to royalty. Previously, in Watkins, the Court noted the presence of similar conflicting mineral and royalty labels and coincident stripping of rights, stating that the parties therein intended the reserved interest to be a royalty interest, and that any other interpretation would necessarily disregard the clause stating that the interest was a royalty.

In French, the Court had the option to follow the Watkins precedent and hold that the stripping away of other sticks of the mineral estate bundle was intended to adequately describe the royalty interest being conveyed. Instead, the Court addressed the royalty label in the second paragraph, noted that the remainder of the paragraph stripping the interests was best interpreted as explaining the consequences of a “royalty only” description, and somehow reasoned that if the interest to be conveyed was only a royalty interest, then stripping of the executive, delay rental, and bonus rights would be redundant. In other words, per the Court, when a deed conveys a royalty interest by the mechanism of granting a fractional mineral estate followed by reservations, what is conveyed is a fraction of royalty, not a fixed fraction of total production.

The Texas Supreme Court offered some clarity to its stance on conflicting mineral and royalty labels with Temple-Inland Forest Products Corp. v. Henderson Family P’ship, Ltd., 958 S.W.2d 183 (Tex. 1997). The Court used Temple-Inland to address some of the conflicts between French and its prior inconsistent decisions in Watkins and Altman, and offered further insight as to which clauses should be given greater weight when harmonizing conveyance instruments.

In Temple-Inland, the Court interpreted the following reservation language:

In respect to the undivided 1/16 part of and interest in the oil, gas and other minerals retained and reserved by the Grantor…it is understood and agreed that said 1/16 interest is and shall always be a royalty interest, and shall not be charged with any of the costs which the Grantee may incur in [production]; and…the Grantor’s 1/16 royalty interest above referred to shall be delivered free of cost. It is expressly understood that…all drilling operations and development for oil, gas and other minerals…shall be solely at the Grantee’s option and election. [G]rantor shall not be required to join in or ratify any oil and gas mining lease. [G]rantor shall be entitled to none of the bonus money therefor and to no part of the delay rentals.

The Court first stated that its decision in French (somehow) did not overrule Watkins, noting that the key distinction between the two cases was a reference to “royalty acres” in the deed at issue in French. The Court referenced Williams & Meyers § 320.3 as supporting the argument that the owner of 50 royalty acres out of the 32,808.5 acres at issue in French would be entitled to 50/32,808.5 of royalty, and not a fixed 50/32,808.5 royalty interest. The Court conveniently omitted the portions of § 320.3 that discuss alternative views of the definition of a royalty acre, including the suggestion that the conveyance of “50 royalty acres” in a 100 acre tract might be regarded as the equivalent of a 1/2 royalty (or, in the French instance, a fixed 50/32,808.5 royalty interest).

The Court further noted that in Temple-Inland, (i) the deeds at issue used the word “royalty” no less than six times, and (ii) the reserved interest was stated to be free of exploration and production costs. In the Court’s view, the liberal use of the royalty label and the fact that a royalty interest, unlike a mineral interest, bears no exploration and production costs, were sufficient to create a royalty interest despite stripping elements of the bundle of sticks just like in French. The Court also clarified that in order to create a royalty interest, it is not necessary to state that the interest being created or reserved come from “actual production”, a misunderstanding created by the Court’s previous focus on such language in Watkins. If the reader finds this judicial landscape frustratingly uncertain and lacking in hardline black letter rules, then this post has been successful, and the reader is now better suited to oil and gas conveyance interpretation in Texas.

For drafting attorneys, the key takeaways from the above cases include the following: (i) do not include conflicting mineral and royalty labels; (ii) when drafting a fixed NPRI conveyance, do not strip away all the remaining elements of the mineral estate, but instead state that the interest shall be a royalty interest; (iii) stating that an interest will bear no cost goes a long way toward effectively describing a royalty interest; and (iv) stating that an interest is from actual production is not necessary to create a royalty interest.

For landmen and title attorneys, who will almost never encounter the exact conveyance or reservation language found in case law, the key takeaways from the above cases include the following: (i) the Texas Supreme Court can be inconsistent in its decisions; (ii) when harmonizing the four corners of an instrument, not all clauses will be harmonized equally; and (iii) if there is a doubt as to the interpretation of an instrument of conveyance, there is no doubt that it is time to either understand and accept the business risk involved with the particular instrument or take curative action.

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