ConocoPhillips Company v. Kenneth Hahn: Can a lease ratification convert an NPRI from fixed to floating? The Texas Supreme Court says no under most circumstances.
In the case of ConocoPhillips Company v. Kenneth Hahn, No. 24-0024, decided on December 31, 2024, the Texas Supreme Court considered whether a fixed nonparticipating royalty interest (“NPRI”) was subsequently converted into a floating NPRI by virtue of a lease ratification and/or a stipulation of interest. The Court dismissed the argument that the ratification converted the NPRI but agreed with Conoco that the stipulation was effective to convert the NPRI.
Background:
Kenneth Hahn owned all of the surface and an undivided 1/4 mineral interest in 37.07 acres located in Dewitt County, Texas. In 2002, Hahn conveyed the 37.07 acres to William and Lucille Gips by general warranty deed (the “Gips Deed”) and reserved to himself a fixed 1/8 NPRI for a term of 15 years. In 2010, the Gipses leased the 37.07 acres to ConocoPhillips under an oil and gas lease (the “Gips Lease”) containing a 1/4 royalty. In 2011, Hahn executed a ratification of the Gips Lease (the “2011 Ratification”).
Conoco subsequently approached Hahn about the need to clarify the royalty interest reserved in the Gips Deed. As a result, Hahn and the Gipses executed a stipulation of interest (the “Stipulation”), with cross-conveyance language, in which the parties agreed that the interest reserved in the Gips Deed was “a one-eighth (1/8) ‘of royalty’ for a term of 15 years.”
In 2012, Conoco added the 37.07 acres to its “Maurer Unit B” and sent Hahn a division order reflecting that he owned a fixed 1/8 NPRI. However, a dispute subsequently arose between Conoco and Hahn as to the nature of Hahn’s NPRI, with Conoco asserting that the fixed NPRI was later converted into a floating NPRI because (1) Hahn ratified the Gips Lease and (2) Hahn signed the Stipulation. Note that Hahn’s 1/8 fixed NPRI was twice the amount of the 1/16 royalty owed under the Gips Lease (1/4 MI x 1/4 RI = 1/16)). Thus, if the NPRI was fixed, then Conoco would have to pay significantly more royalty than was owed under the Gips Lease.
Issue 1: Whether the 2011 Ratification Changed Hahn’s NPRI from Fixed to Floating
Conoco argued that Hahn, by ratifying the Gips Lease, was thereby bound to all of the lease’s provisions, including the 1/4 landowner’s royalty provision. Conoco asserted that Hahn could not accept the benefit of the pooling provisions but rejected the royalty provision. Conversely, Hahn argued that a fixed NPRI, by definition, cannot be diminished by the landowner’s royalty and that the 2011 Ratification was effective only as to the Gips Lease’s pooling provisions. Ultimately, the Court agreed with Hahn.
The Court’s decision turned on the different nature of the interests involved. An NPRI is a non-possessory interest in production, and therefore its owner has no executive rights and cannot enter into an oil and gas lease. The mineral fee owner, on the other hand, possesses such executive rights and can make and amend leases and negotiate their terms and provisions.
Despite the power of the executive rights owner to execute leases, Texas courts have held that an NPRI cannot be pooled without the owner’s consent. This is because pooling effects a cross-conveyance of interests which effectively dilutes each party’s royalty interest based on their respective tract participation rate. Under Texas law, a lease with pooling provisions is considered an offer to pool made by the lessor to the royalty owners, which offer can be accepted or rejected. By ratifying the Gips Lease, Hahn accepted the offer to pool and agreed to have his royalty interest apportioned on a pooled unit basis, as opposed to a tract basis.
Having established that NPRI owners may elect to accept a lease’s pooling provisions by means of a lease ratification, the Court then turned its attention to the landowner’s royalty provision. The Court held that, by ratifying the Gips Lease, Hahn did not also agree to have his interest become subject to the landowner’s royalty. The Court explained that an NPRI owner “has no executive rights and is therefore due none of the entitlements owed to the lessor,” such as shut-in royalties, delay rentals, or the landowner’s royalty. In other words, as a non-possessory interest in production, some provisions in a lease can apply to an NPRI, while others cannot. Further, the Court stated that the landowner’s royalty cannot apply to a fixed NPRI because such an interest is a fixed share of total production which remains constant regardless of the amount of royalty reserved in the currently effective oil and gas lease. Therefore, the Court ruled that the 2011 Ratification did not reduce Hahn’s NPRI.
The Court noted that the outcome on this issue could have been different had the Gips Lease contained provisions that purport to modify nonparticipating royalty interests. However, the Gips Lease did not contain language to that effect.
Issue 2: Whether the 2011 Stipulation Changed Hahn’s NPRI from Fixed to Floating
The second issue in this case dealt with whether or not the Stipulation was enforceable. If enforceable, the Stipulation would reduce Hahn’s NPRI from a fixed 1/8 of total production to a 1/8 of the 1/4 royalty reserved in the Gips Lease.
At the appellate level, the Corpus Christi Court of Appeals held that because the Gips Deed was unambiguous, the Stipulation could not be considered in construing the Gips Deed without violating the “four corners rule.” In other words, the Stipulation was immaterial because it was outside the four corners of the unambiguous Gips Deed.
The court of appeals declined to follow the Texas Supreme Court’s intervening decision in Concho Resources, Inc. v. Ellison, 627 S.W.3d 226 (Tex. 2021), wherein the Court held that a written boundary line stipulation was enforceable without evidence of ambiguity in the underlying title instruments. The court of appeals asserted that Concho Resources was distinguishable from the case at hand in two respects: (1) Concho involved a boundary line dispute (as opposed to an NPRI) and (2) the underlying instruments giving rise to the dispute were ambiguous. Thus, the court of appeals ruled that the Stipulation was not enforceable.
The Texas Supreme Court disagreed with the court of appeals and held that the lower court’s failure to give effect to the Stipulation was contrary to the Court’s decision in Concho Resources. The Court explained that written settlement agreements are greatly favored in the law as a means of amicably resolving uncertainties and preventing litigation. Requiring proof of ambiguity “would scuttle” such agreements because parties would never know if their informal settlements were enforceable. Further, the Court stated that its decision in Concho Resources was not limited to boundary lines. Therefore, the Court ruled that the Stipulation was enforceable so that Hahn’s NPRI was reduced from a fixed 1/8 to a 1/8 of the 1/4 lease royalty.
Takeaways:
ConocoPhillips v. Hahn affirms that NPRI owners who ratify a typical oil and gas lease are merely agreeing to have their interests pooled under the lease’s pooling provisions. However, the ratifying party should ensure that the lease does not contain provisions which purport to affect or modify NPRIs.
This case affirms that stipulations of interest are an effective means of resolving title issues, including disputes regarding the nature or amount of NPRIs. As noted, stipulation agreements are favored by the courts because they allow parties to avoid costly litigation.
Further, this case demonstrates that the holding in Concho Resources, which dealt with a boundary line stipulation, can also apply to a stipulation clarifying a royalty interest. Thus, the underlying deed creating the NPRI need not be ambiguous in order for the parties to clarify the interest with a stipulation agreement.