Know How: Alert

Title

TX Supreme Court Declines to Articulate Bright Line Rule in Executive Duty Case

GET KNOW HOW

Subscribe

Stay up-to-date with industry knowledge!

On March 6, 2015, the Texas Supreme Court issued a decision in KCM Financial, LLC v. Bradshaw.  In this case, the Court examined the duty an executive-right holder owes to a non-participating royalty interest owner (non-executive) in the case of a sub-market royalty rate.  The Court declined to articulate a bright line rule to delineate the boundaries of an executive’s duty.

On the issue of the lessee’s duty to the non-executive, the Court held that Bradshaw’s derivative liability claims against Range failed as a matter of law, determining that there was no evidence that Range was complicit in KCM’s alleged breach of duty or otherwise had any duty to Bradshaw in its dealings with KCM.

Background:

Betty Lou Bradshaw (“Bradshaw”) owns an undivided one-half non-participating royalty interest in the Mitchell Ranch. The language reserving the royalty interest mandated that any future royalty be not less than one-eighth, which was the standard minimum at the time of the 1960 deed reserving the interest.  The non-participating royalty interest, being non-executive in nature, entitled Bradshaw to receive an interest in the gross production (the royalty interest), but did not include the right to negotiate lease terms or to receive any delay rentals or bonuses. 

The mineral estate owner, Steadfast Financial LLC (now “KCM”), negotiated and executed a mineral lease with Range Production I, L.P. (“Range”), under the terms of which KCM reserved a one-eighth royalty and received a bonus of $7,505 per acre, totaling more than $13 million for the portion of the property burdened by Bradshaw’s interest.

Bradshaw filed suit alleging that KCM violated its fiduciary duty to her because the customary royalty rate at the time and place of lease execution had increased to one-fourth.  According to Bradshaw, KCM engaged in self-dealing by negotiating a higher bonus payment at the expense of securing a higher royalty. Bradshaw further asserted that Range conspired with and aided and abetted KCM’s breach.  KCM argued that there was no breach because it obtained the minimally acceptable royalty and it was the “same” for both the executive and non-executive.

Through a series of appeals, this case came before the Court on the threshold issue of whether evidence exists from which a jury could conclude that KCM breached a duty to Bradshaw in negotiating the terms of the mineral lease.

Supreme Court’s Decision:

The Supreme Court reasoned that in determining whether the executive breached its duty to the non-executive, the inquiry is “whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.”  The Court found that, if proved, the allegation that the executive misappropriated a shared benefit, such as royalty, and converted it into a benefit only for itself, such as bonus, with the intent to diminish the value of the shared benefit, such conduct would constitute self-dealing.  The Court declined to conclude that “merely obtaining the minimally acceptable royalty discharges, as a matter of law, the executive’s duty.”  In analyzing the executive’s duty, the transaction must be viewed as a whole, which requires a review of all lease terms.  

Finding that, while “failure to obtain a market-rate royalty does not, in and of itself, constitute a breach of [the executive’s] duty,” there was at least some evidence to support Bradshaw’s allegation that the mineral lease was the product of self-dealing.  The Court therefore affirmed the court of appeals’ judgment as to the breach of duty claim finding that summary judgment was not proper because a fact question existed.

In holding that Bradshaw’s derivative liability claims against Range failed as a matter of law, the Court determined there was no evidence that Range was complicit in the alleged breach of duty or otherwise had any duty to Bradshaw in its dealings with KCM.  Range, as lessee, engaged in “nothing more than a typical business transaction.”  The Court agreed that “in negotiating with the executive, a lessee should not fear liability for doing nothing more than getting a good deal closed.”   The Court held that even if KCM is found to have breach a duty owed to Bradshaw, its liability cannot be imputed to Range as a matter of law and rendered judgment that Bradshaw take nothing on that claim.

The Court also examined claims regarding constructive trust and fraudulent transfer. 

Conclusion

In summary, the Court reaffirmed a principle existing in jurisprudence for eighty years: “[a]n executive owes a duty of utmost good faith and fair dealing to a non-executive,” and may not engage in self-dealing.  The Court declined to rule that a sub-market royalty rate, in itself, constitutes a breach of duty.   As such, we will continue to see cases for breach of duty in Texas courts, which require an examination of all the evidence, not just whether there was a sub-market royalty rate.     

Contributors