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Energy Law Exchange

December 11, 2018

Rights of First Refusal: New Texas Supreme Court Case Expands a Right-Holder’s Ability to Unwind a Conveyance for which It Did Not Receive Notice

The ownership of oil and gas mineral interests is often subject to a right of first refusal—commonly known by its acronym ROFR or the short-hand “preferential right.” This right generally grants a third party the option to purchase another’s interests on the same terms that they offered to a prospective bona fide purchaser. A party often pays meaningful consideration to obtain a ROFR on another’s property. Where a party already owns an interest in the asset, the ROFR helps to protect against unwanted business partners and acts as a vehicle by which one can increase his or her interest in the asset. Conversely, this option burdens the interest, potentially causing it to be less valuable and restricting the owner’s ability to sell it. This often creates tension between the ROFR-holder and interest owner. As a result, both parties may interpret the scope of the ROFR differently, leading to litigation and uncertainty.

The Archer Trust Opinion

In Carl M. Archer Trust No. Three et al. v. Ronald Ralph Tregellas et al., the Texas Supreme Court addressed what happens when a ROFR-holder discovers years later that interests burdened by its options were conveyed to a third party without notice and an opportunity to exercise its option. In March 2007, Tregallas acquired royalty interests, which were burdened with a ROFR in favor of Archer Trust. The sellers of the royalty interests failed to notify Archer Trust of the bona fide offer for the royalty interests and of the price, terms, and conditions of the Tregallas offer—as was required by terms of the ROFR. It was not until more than four years later that Archer Trust discovered that the royalty interests had been conveyed in breach of the terms of its ROFR.

Archer Trust immediately filed suit, seeking specific performance of its ROFR (i.e., that it be given the belated opportunity to exercise its option), an order requiring Tregallas to transfer the royalty interests to Archer Trust, and for damages. Tregallas answered against the lawsuit, claiming that Archer Trust had no right to unwind the more than four-year old conveyance because any claim for breach of the ROFR was time-barred due to the expiration of Texas’ four-year statute of limitations.

The Texas Supreme Court held that Archer Trust’s cause of action accrued in March 2007, when the contract was breached and the property was transferred without providing Archer Trust the requisite notice. As a result, Archer Trust’s claim would be time-barred unless the accrual of the statute of limitations was deferred because the cause of action was not “inherently discoverable.”

Texas law defers the accrual of a cause of action in certain instances until the plaintiff knew or should have known of the facts giving rise to the cause of action. The royalty interests constitute real property, the conveyance of which must be recorded in the public records. Tregellas argued that anyone, including Archer Trust’s trustees, could have discovered the conveyance by reviewing the county conveyance records. Archer Trust responded that it would have no reason to suspect that its interest in the property may have been impaired and, thus, reasonable diligence would not require it to “continually monitor public records for evidence of such an impairment.” The Texas Supreme Court agreed, concluding that absent some reason to suspect that its right had been violated, a party with no notice of a conveyance was under no duty to investigate the public records. As a result, Archer Trust’s claim was not time-barred as it was filed within four years of when it had reason to know of its claim.

Are Texas courts becoming more friendly for the holders of ROFRs?

The Archer Trust opinion may represent a shift by Texas courts back towards the ROFR-holder. Texas courts have historically sided with the interest owners, strictly construing ROFRs and permitting the conveyance of mineral interests free and clear of any ROFR so long as the transaction satisfied the express language of the terms. This is best exemplified in Tenneco Inc. v. Enterprise Prods, 925 S.W.2d 640 (Tex. 1996), which approved of the “Texas Two-Step” transaction to convey mineral interests without triggering the ROFR—even if doing so would frustrate the spirit of the ROFR.

Typical ROFR provisions, such as those found in the American Association of Professional Landmen Form 610 Operating Agreement, are not triggered when interests are conveyed to a subsidiary. The “Texas Two-Step” transaction involves, first, a parent company’s conveyance of the burdened interest to a subsidiary (often newly created with no assets other than the newly acquired mineral interest) and, second, the parent company’s sale of the entire subsidiary to a third party. In this way, the mineral interests are not conveyed; rather, it is the equity in the subsidiary, to which no ROFR exists, that is sold. While approved by Texas courts, other jurisdictions such as Wyoming have rejected similar two-step transactions as constituting an impermissible attempt to frustrate the ROFR. See Williams Gas Processing--Wamsutter Co. v. Union Pac. Res. Co., 25 P.3d 1064, 1072 (Wyo. 2001).

Archer Trust clearly marks a victory for ROFR-holders, but it is unclear whether this is the beginning of a trend. While interest owners likely will try to limit the breadth of this opinion, we expect ROFR-holders to argue that this opinion indicates the Texas Supreme Court’s approval for more expansive protections.

What lessons can be learned from Archer Trust?

Transparency and disclosure will protect a conveyance from being challenged years later. In Archer Trust, the seller failed to provide any notice of the conveyance and, as a result, the ROFR-holder had no reason to investigate whether its right may have been violated. While an interest owner may have a valid reason to believe that a particular conveyance does not trigger the ROFR, it may be well served to provide some notice to the ROFR holder of its intent to convey the interest free and clear of the ROFR. While this may result in additional questions from the ROFR-holder as to the nature of the transaction, it will have knowledge of the transaction and its time to take legal action will begin to accrue. The downside, however, is that the ROFR-holder may well attempt to exercise its option or take other actions that might complicate the transaction.

Additional due diligence by the purchaser of the burdened interest may be warranted. Obtaining a representation from the seller that no ROFR applies or that notice has been given may be insufficient when the purchaser is at risk of having to re-convey the property at some future date to the ROFR holder and to disgorge any profits from the property. Given that Archer Trust now permits the potential resurrection of what may formerly have been considered time-barred claims, title examinations should pay particular attention to whether prior conveyances gave notice of the transaction to ROFR holders.