In Gloria’s Ranch, L.L.C. v. Tauren Exploration, Inc., the Louisiana Second Circuit upheld a trial court’s ruling that the holder of a security interest in mineral leases was solidarily liable for damages under the Louisiana Mineral Code stemming from its mineral lessees/mortgagors’ actions.[1] In the case, a landowner sued its mineral lessees for: (1) failure to provide a recordable act evidencing the expiration of a mineral lease under Mineral Code articles 206-209 and (2) failure to pay royalties under Mineral Code articles 137-140.[2] However, the landowner also filed suit against the holder of a mortgage encumbering the mineral lease at issue (referred to herein as the “Lease”) and claimed that the mortgagee was solidarily liable with the mineral lessees.[3] After a bench trial at the district court level, the Court found in favor of the landowner and awarded the following damages pursuant to the Louisiana Mineral Code:

  1. $22,806,000.00 for lost leasing opportunities as a result of the defendants’ failure to provide a recordable act evidencing the expiration of a mineral lease under Mineral Code articles 206-209 and a declaration that certain portions of the Lease covering the landowner’s property had expired due to a failure to produce in paying quantities.[4]
  1. $242,029.26 in unpaid royalties and an additional double damages penalty of $484,058.52 for failure to pay royalties under Mineral Code article 140.[5]
  1. Cancellation of the remainder of the Lease covering the landowner’s property pursuant to Mineral Code article 140.[6]
  1. $936,803.00 in attorney’s fees under Mineral Code articles 140 and 206.[7]

The trial court did not simply find that the mineral lessees were liable for damages. It also held that the holder of the mortgage over the Lease was solidarily liable as well.[8] In its reasons for judgment, the trial court found that the mortgagee was solidarily liable with the mineral lessees because: (1) the mortgage contained an assignment of the secured Lease to the mortgagee; (2) the mortgage provided that the mineral lessees could not release the Lease without the mortgagee’s consent; (3) the mortgagee held an overriding royalty and net profits interest in the Lease; and (4) the mortgagee received financial information from the mineral lessees and regularly audited their records.[9]

The mortgagee appealed the trial court’s decision to the Second Circuit and claimed that it was not solidarily liable with the mineral lessees for the damages awarded to the landowner under the Louisiana Mineral Code.[10] First, the mortgagee claimed that the trial court erred in its conclusion that the mortgagee was assigned a portion of the working interest in the Lease because the mortgage only granted the mortgagee a security interest in the Lease.[11] After analyzing the language of the mortgage at issue, the Second Circuit agreed with the mortgagee and found that the mortgage only granted a security interest in the Lease as opposed to ownership in the working interest of the Lease.[12]

Despite finding that the mortgagee did not own a working interest in the Lease, the Second Circuit accepted the landowner’s argument that the mortgagee was still solidarily liable with the mineral lessees because it “owned or controlled the bundle of rights that make up ownership, i.e., the rights to use, enjoy, and dispose of the lease.”[13] In reaching this conclusion, the Court made note of the following aspects of the mortgage that showed the mortgagee exercised control over the mineral lessees’ right to conduct oil and gas operations pursuant to the Lease:

  1. The credit agreement between the mortgagee and the mineral lessees directed that the loan proceeds be used to repay debts and develop the mineral lessees’ oil and gas properties, including reimbursing or paying itself for the costs associated with drilling three wells into the Cotton Valley or Haynesville Shale formations on the leased property.
  1. The mortgagee retained the right to approve the location and depth of the wells drilled under the Lease and other mineral leases subject to the mortgage.
  1. The mortgagee directed the mineral lessees to perform specific workovers and completions on other properties collateralized in the mortgage.
  1. The mineral lessees were required to provide the mortgagee with quarterly and annual financial statements reflecting their financial condition, reserve reports showing projections of further net income from the mortgaged properties, and sales and production reports which included the actual revenue and operating expenses of the wells.
  1. The mortgage provided that the mortgagee had the right to access the leased premises “at all times.”
  1. The mortgage provided that the mineral lessees could not enter into new operating agreements or amend existing operating agreements without written consent of the mortgagee.[14]

The Second Circuit also found that the mortgagee held rights to enjoy and alienate the Lease for the following reasons:

  1. The mortgagee received an assignment of the proceeds from the mineral lessees’ interest in the lease, and pursuant to the transactions with one of the mineral lessees under the mortgage, acquired an overriding royalty and net profits interest in the Lease.
  1. The mortgagee controlled the mineral lessees’ ability to alienate their interest in the Lease by requiring the mineral lessees to obtain the mortgagee’s written consent to release the Lease.[15]

Based on these reasons, the Second Circuit held that the trial court correctly found the mortgagee solidarily liable with the mineral lessees for damages under the Louisiana Mineral Code.[16] In its reasoning, the Court referenced Louisiana Civil Code article 1979, which provides that “[a]n obligation may be solidary though it derives from a different source for each obligor.”[17] In addition, it noted that “[i]t is the coextensiveness of the obligations for the same debt, and not the source of the liability, which determines the solidarity of the obligation.”[18] Utilizing this rationale, the Court found that the mortgagee shared coextensive liability with the mineral lessees because the mortgage was a sophisticated financial instrument that allowed the mortgagee to exercise control over the mineral lessees’ oil gas operations and ability to release the Lease for failure to produce in paying quantities.[19]

Although the Second Circuit found solidary liability in this instance, it is important to note that the Court stated that the case at issue was “highly fact-intensive and should not be construed as governing other cases that may follow unless the same facts exist.”[20] Nonetheless, the Second Circuit’s finding that the holder of a security interest in a mineral lease may be solidarily liable with mineral lessees/mortgagors for damages under the Louisiana Mineral Code is certainly concerning given the fact that many operators finance their operations through the usage of security and credit devices. Therefore, despite the fact that the Second Circuit included language that arguably limited the precedential effect of its ruling, parties that enter into security and credit agreements with operators looking to finance oil and gas development should be mindful of the provisions in such agreements that could grant the holder of the security interest certain rights to use, enjoy, and alienate any mineral interests secured under the agreement.

The Second Circuit’s decision also addressed issues involving production in paying quantities and failure to pay royalties under the Louisiana Mineral Code, and a detailed discussion of those issues is also located on The Energy Law Blog. If you would like additional information on this case and its potential implications, please contact Brittan J. Bush (bjbush@liskow.com), Caleb J. Madere (cjmadere@liskow.com), or Jamie D. Rhymes (jdrhymes@liskow.com). 

*Brittan J. Bush and Caleb J. Madere are Associates, and Jamie D. Rhymes is a Shareholder in Liskow & Lewis’ Lafayette, Louisiana office. Any views expressed herein are those of the authors and do not necessarily reflect the views of Liskow & Lewis and/or its clients. Furthermore, it is the authors’ intention to provide the information contained herein in an objective fashion that presents the practical effects of particular legal decisions without any commentary as to whether a particular decision is legally correct or sound policy. In the interest of full disclosure, Liskow & Lewis served as appellate counsel for Cubic Louisiana, L.L.C. in this matter.

[1] Gloria’s Ranch, L.L.C. v. Tauren Exploration, Inc., et al., 51, 077 (La. App. 2 Cir. 6/2/17). A copy of the Second Circuit’s decision is available at http://www.la2nd.org/archives/docs/410ecc.pdf. As of the posting of this blog entry, the delays for appeal have yet to expire.

[2] See id. at p. 4-5.

[3] The Lease was executed in September 2004 and covered 1,390.25 acres in Sections 9, 10, 15, 16, and 21, Township 15 North, Range 15 West in Caddo Parish, Louisiana. The Lease, which contained vertical and horizontal Pugh clauses was originally granted to Tauren Exploration, Inc. (“Tauren”) In February 2006, Tauren assigned an undivided 49% interest in the Lease to Cubic Energy, Inc. (“Cubic”) In October 2009, Tauren assigned its 51% interest in the Lease as to all depths below the Cotton Valley formation to EXCO USA Asset, Inc. (“Exco”). See id. at 1-4.

[4] The trial court found that the portion of the Lease covering Sections 9, 10, 16, and 21 had expired as a result of a failure to produce in paying quantities. It awarded lost leasing damages for 1,267 acres at a rate of $18,000.00 per acre. Damages for lost leasing opportunity were not awarded for the portion of the Lease covering Section 21 by virtue of a top lease previously executed by the landowner and a third party. See id. at 4.

[5] See id. at 5.

[6] While the Lease did not expire as to the portion of the property in Section 15 as a result of a failure to produce to in paying quantities, the trial court’s judgment cancelled that portion of the Lease as damages under Mineral Code article 140. See id.

[7] See id.

[8] See id. at 22. The mineral lessees executed credit agreements with Wells Fargo Energy Capital, Inc. (“Wells Fargo”) that provided the mineral lessees with a revolving credit facility. As a security for the loans, the mineral lessees mortgaged their interests in mineral leases with various landowners, and collaterally assigned the profits therefrom. See id. at 2.

[9] See id. at 25. “By virtue of the Exco sale, Wells Fargo released the mortgage it had on Tauren’s interest after receiving repayment and compensation pursuant to the credit agreement. As a condition of Wells Fargo releasing the mortgage, Tauren assigned a 10% interest in its shallow rights interest in the lease to Wells Fargo. Additionally, on November 9, 2009, Cubic assigned to Tauren an overriding royalty interest in the deep rights of its 49% interest in the lease. Tauren immediately assigned a portion of the overriding royalty interest to Wells Fargo.” Id. at 4.

[10] See id. at 22-33.

[11] See id. at 25-31.

[12] See id.

[13] Id. at 31.

[14] See id. at 31-32.

[15] See id. at 32.

[16] See id. at 32-33.

[17] Id. at 33.

[18] Id. (citing Glasgow v. PAR Minerals Corp., 2010-2011 (La. 05/10/11), 70 So. 3d 765, 772; Stonecipher v. Mitchell, 26. 575 (La. App. 2 Cir. 05/10/95, 655 So. 2d 1381, 1386).

[19] Id.

[20] Id. at 35.