Hahn v. Conoco Phillips Co.[1] presents a thorny but ultimately predictable analysis of issues impacting nonparticipating royalty interests (“NPRIs”) in Texas.
Kenneth Hahn (“Kenneth”) owned all of the surface interest and an undivided 1/4 mineral interest in 37.00 acres in Dewitt County, Texas. He sold these interests to William and Lucille Gips (the “Gipses”), reserving a 1/2 of 1/4 NPRI. Put differently, Kenneth reserved an undivided 1/8 “fixed” NPRI.[2] The Gipses later entered into a lease with ConocoPhillips (“Conoco”) that contained a 25% landowner royalty provision and pooling authority, entitling the Gipses to 1/16 (1/4 of 25%) of production. Kenneth ratified the lease as to the pooling provision.
A dispute arose in the wake of this ratification as to whether Kenneth was owed a full 1/8 (1/2 of 1/4) NPRI, or a lesser 1/32 (1/2 of 1/4 of 25%) NPRI. A full 1/8 NPRI would be problematic for both the Gipses and Conoco as it would not only absorb the Gipses’ 1/16 landowner royalty, but Conoco would in theory have to account for the additional 1/16 royalty payment out of its net revenue interest (diluted for pooling).
Central to this case was Conoco’s argument that Kenneth’s NPRI “was reducible by a landowner’s royalty contained in an oil and gas lease,”[3] and was thus a “floating” 1/2 of 1/4 of royalty as opposed to a “fixed” 1/8. Conoco’s assertion was that Kenneth’s NPRI was now reducible by the 25% landowner royalty (being a 1/32nd NPRI), in addition to the unit participation factor of the pooled lease because he ratified the Gipses’ oil and gas lease. Kenneth of course disagreed, maintaining that his NPRI was “fixed” at the larger 1/8th. The Corpus Christi Court of Appeals sided with Kenneth.
It’s important to note that the Court of Appeals had previously held that Kenneth retained a fixed 1/8th NPRI in his deed to the Gipses.[4]. Thus, Conoco attempted in this second appeal an alternate (and somewhat novel) argument.[5] It asserted that even if the interest was fixed Kenneth later agreed to convert his fixed NPRI into a floating NPRI.[6] In essence, Conoco made the argument that by ratifying the lease and consenting to pooling, Kenneth’s NPRI was transmogrified from fixed to floating.
Conoco pointed to scant caselaw in arguing its point, and none of the cases squarely addressed the issue at hand. In this case, Kenneth signed a ratification of the oil and gas lease between Conoco and the Gipses. The established rule, per the court, is that the ratification of an oil and gas lease by an NPRI owner serves only to bind the NPRI owner to the pooling provision in the lease.[7] While there are caveats, the rationale for this standard is that “[b]ecause pooling affects royalty interests, an executive lacks the power to bind an NPRI to a pooling provision absent the NPRI owner’s consent.”[8] Thus, the ratification is necessary to dilute an NPRI on a pooled basis, unless the operator wants to pay out royalties on a non-pooled basis.
Ultimately, the Court of Appeals held that Kenneth did not convert his fixed NPRI into a floating NPRI when he ratified the oil and gas lease between the Gipses and Conoco. In fact, the court noted that “Conoco cites no authority, and we have found none, where a fixed NPRI was converted into a floating one in any circumstance.”[9] Despite its decision, the court does go on to note that there are scenarios where an NPRI owner might end up converting his interest. For example, such a situation could play out if: (1) the oil and gas lease contained provisions that explicitly purported to diminish the NPRI interest; and (2) the NPRI owner subsequently ratified that lease.[10].
A petition for review was filed on March 2, 2023. Despite the ultimate outcome of this case, it may be best practice for NPRI owners to avoid broad blanket ratifications of an oil and gas lease if the intent was to only to consent to pooling or to ratify select provisions of the lease. For example, an NPRI owner who is only consenting to the pooling of his interest might expressly limit his ratification or style it as a “consent to pooling.” Otherwise, it may be argued that that he has conscripted his interest to other lease provisions which may or may not be beneficial and which might include, e.g., the calculation of his interest (as argued in Hahn), provisions regarding the deduction of post-production costs, separate lease or retained acreage provisions, the effect of unsigned division orders, or the timing of royalty payments.[11]
[1] 2022 Tex. App. LEXIS 8812 (Tex. App.—Corpus Christi – Edinburg 2022, pet. filed).
[2] Id. at 5.
[3] Id. at 1.
[4] Hahn v. Gips, Tex.App. LEXIS 1098 (Tex. App.—Corpus Christi – Edinburg 2018, no pet.)
[5] Many thanks to Terry Gamble, who represents Hahn in this matter, for clarifying this point.
[6] 2022 Tex. App. LEXIS 8812 at 18.
[7] Id. at 25.
[8] Id. at 26.
[9] In fact, the court noted that “Id. at 23-24.
[10]. Id. at 42. Of further note in the Court’s opinion is a discussion of the “law-of-the-case” doctrine, ratification generally, and a review of the law of ratification and pooling with regard to NPRIs.
[11] See generally, Christopher S. Kulander, Down Step by Step-Ratification of Oil and Gas Leases by Royalty Interests in Texas, 73 SMU L. REV. 251 (2020).
*This case law update was originally published December 2022. Updated January 10, 2024.
Brad represents clients in connection with upstream energy transactions, complex mineral titles, pooling issues, lease analysis, joint operating agreements, surface use issues, title curative and general oil and gas business matters.