Much attention has been paid recently to the terms of oil and gas leases in light of the increasing exploration and production activity in the Marcellus Shale region.  But in other parts of the country, particularly Texas and Oklahoma, oil and gas royalties are old hat.  Which may be why, in a December 16, 2011 decision, the Supreme Court of Texas held that a lessor of gas rights was barred by the statute of limitations from recovering underpayments made by Shell Oil Company – which had unabashedly admitted at trial that it had underpaid the plaintiff’s predecessor-in-interest for at least 3 years, and possibly ten years, and that in doing so it had breached its contract.

The facts in Shell Oil Co. v. Ross, No. 10-0429 (Dec. 16, 2011), are rather simple.  The Plaintiffs’ predecessors had entered into a mineral lease with Shell in 1961 which provided for royalty payments based upon “the amount realized” by Shell for any gas produced from the land.  Portions of the leased property were placed into two pooled units and Shell paid royalties on gas produced from two wells on the leased property and on gas produced from off-site wells.  For reasons not clear in the opinion, from 1994 – 1997, Shell paid an “arbitrary” price for the gas produced from the on-site wells, and from 1988 – 1994, paid a weighted average price for the gas produced from the off-site wells.  The lawsuit was not initiated, however, until 2002.  

Both of these methods of calculation were determined to be breaches of the Lease, and the only question was whether the Statute of Limitations was tolled by either Shell’s fraudulent concealment or by the delayed discovery rule.  The jury and the appellate court found in favor of the Plaintiffs, holding that Shell’s actions in sending payments with the incorrect prices on the stubs amounted to fraudulent concealment.  The Supreme Court reversed, however, finding that the Plaintiffs should have been on notice that something was amiss as there was a substantial difference in the royalties being paid on the on-site wells and that being paid on the off-site wells and that, through various public sources, the Plaintiffs could have discovered the incorrect pricing.  As a result, the Plaintiffs were not entitled to take advantage of either tolling theory.

On its face, this decision is not that surprising.  Rather, it seems that both the jury and the appellate court may have been swayed by the David-and-Goliath nature of the case, deciding that the Plaintiffs should not be charged with the ability to understand the complicated royalty payment scheme and the obligation to dig into and understand various public filings and records – none of which disclosed the exact sale prices that the royalties were tied to – to determine the existence of the underpayment.  What the Supreme Court noticed, however, was that one of the Plaintiffs was “a lawyer who had done oil and gas work, and thus understood the oil and gas industry.”  While the decision does not expressly relate that fact to the outcome, one suspects that the lack of naiveté on the part of the Plaintiffs made it easier for the Court to hold that the Plaintiffs “could have discovered the Shell’s alleged fraud through the use of reasonable diligence.” 

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