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Docket Number

No. C-3894.

Attorney(S)

Mike Hatchell, Ramey Firm, Sam B. Cobb, Jr., Sam B. Cobb, Jr. Associates, P.C., Tyler, for petitioners. K. Ray Campbell, Campbell, Athey Zukowski, Maurice Bresenhan, Jr., Houston, for respondents.

Judges

Franklin S. Spears

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Smart Summary

Gavenda et al. v. Strata Energy, Inc. et al., No. C-3894 — Supreme Court of Texas (Jan. 22, 1986; rehearing denied Apr. 2, 1986)

Factual and Procedural Background

In 1967 the Gavenda family conveyed land but reserved a fifteen-year one-half (1/2) non-participating royalty interest. The land changed ownership several times; in 1976 the then-owner executed an oil and gas lease providing a 1/8th royalty. Strata Energy, Inc. and Northstar Resources, Inc. later acquired working interests in the lease and drilled producing wells in 1979 and 1980. Strata was named the lease operator under a joint operating agreement and was responsible for disbursing royalties.

Relying on a title opinion prepared by an attorney, Strata mistakenly concluded the Gavendas were entitled only to a collective 1/16th royalty (instead of the reserved 1/2). Strata prepared division and subsequent transfer orders reflecting the erroneous 1/16th figure, disbursed proceeds accordingly, and the Gavendas signed the orders and accepted the payments. As a result, the Gavendas were underpaid by 7/16ths of gross production, and Strata and Northstar retained at least part of that underpayment.

On September 29, 1982 the Gavendas revoked the division and transfer orders upon discovering the error; two days later their reserved royalty interest terminated by its express fifteen-year term. Later in 1982 the Gavendas sued to recover more than $2.4 million in alleged underpaid royalties.

Both parties moved for summary judgment. The trial court granted summary judgment for the operators (Strata and Northstar), holding the division and transfer orders were binding until revoked. The court of appeals affirmed in part but remanded as to Victor Gavenda's estate on factual issues. Both parties appealed to the Texas Supreme Court.

Legal Issues Presented

Whether division and transfer orders are binding until revoked when an operator who prepared erroneous orders underpays royalty owners and retains part of the proceeds (i.e., whether the "binding until revoked" rule applies where the operator has been unjustly enriched).
Whether the division and transfer orders were binding on the estate of Victor Gavenda (an issue noted by the court of appeals and contested by the respondents).
Whether the Gavendas are entitled to recover attorney's fees under the cited statute in an action to recover underpaid royalties based on a deed reservation.

Arguments of the Parties

Petitioners' (Gavendas') Arguments

The general rule that division and transfer orders are binding until revoked should not apply where the operator has been unjustly enriched by preparing erroneous orders and retaining proceeds; under such circumstances the Gavendas should be able to recover the royalty deficiencies from Strata and Northstar.
They seek recovery of their underpaid royalties (the amount of the deficiency is alleged and undisputed in total) and request attorney's fees under the applicable Texas statute for recovery of royalty payments based on the deed reservation.

Respondents' (Strata and Northstar) Arguments

Strata and Northstar contend the division and transfer orders were binding, including with respect to Victor Gavenda's estate (the court of appeals had remanded as to that estate because of fact issues).
They do not dispute the deed reserved a one-half royalty or the total amount of the royalty underpayment ($2,435,457.51 plus interest) as stated in the record.
Strata further argued that the attorney who prepared the title opinion was an independent contractor and not Strata's agent; Strata asserted it should not be responsible for the attorney's negligence. (The Supreme Court addressed this contention in its analysis.)

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Exxon Corp. v. Middleton, 613 S.W.2d 240 (Tex. 1981)	Division and transfer orders do not convey royalty interests; division orders are generally binding until revoked. Middleton also held division orders could be binding even without detrimental reliance where the operator did not profit from the discrepancy.	The Court described Middleton as precedent recognizing the binding-until-revoked rule and as an example where operators paid out proceeds without profiting; the Court contrasted Middleton's facts (no unjust enrichment by operator) with the present case (operator retained part of underpayment), concluding Middleton did not control the outcome here.
Phillips Petroleum Co. v. Williams, 158 F.2d 723 (5th Cir. 1946)	Supports the principle that division and transfer orders do not convey or rewrite leases or deeds.	Used to support the proposition that division/transfer orders do not create or alter the underlying royalty interests established by deed or lease.
Chicago Corp. v. Wall, 293 S.W.2d 844 (Tex. 1956)	Recognized the general Texas rule that division and transfer orders bind underpaid royalty owners until revoked; rationale includes preventing double liability to purchasers/operators.	Cited to explain the traditional justification for binding division orders (detrimental reliance and protection of purchasers/operators) and to contrast the present case in which the operator retained part of the proceeds.
Allen v. Creighton, 131 S.W.2d 47 (Tex.Civ.App.—Beaumont 1939, writ ref'd)	Overpaid royalty owners may be sued by underpaid owners to recover overpayments on the basis of unjust enrichment.	Applied to explain that underpaid owners generally have a remedy against overpaid royalty owners based on unjust enrichment, distinguishing recovery from the remedy against the operator who retained proceeds.
Stanolind Oil & Gas Co. v. Terrell, 183 S.W.2d 743 (Tex.Civ.App.—Galveston 1944, writ ref'd)	When an operator prepares erroneous division orders and retains benefit (there is unjust enrichment), the division orders are not binding on the royalty owners.	Cited as precedent for the exception to the binding-until-revoked rule when the operator profits from its error; the Court relied on Terrell to hold the orders were not binding in the present case because Strata retained part of the royalties.
Texas Employers Insurance Ass'n v. Wermske, 349 S.W.2d 90 (Tex. 1961)	Recognizes that an attorney-client relationship is an agency relationship; acts and omissions of the attorney within the scope of employment are regarded as the client's acts (negligence attributed to client).	Used to reject Strata's contention that the title attorney was an independent contractor whose negligence should not be attributed to Strata; the Court attributed the attorney's negligence to Strata.
Atlantic Richfield Co. v. Manges, 702 F.2d 85 (5th Cir. 1983)	Supports recovery of attorney's fees in suits for royalty payments owed under oil and gas leases.	Relied upon (along with Gerdes) to support awarding attorney's fees to the Gavendas in an action to recover underpaid royalties based on a deed reservation, by analogy to lease-based royalty suits.
Gerdes v. Mustang Exploration Co., 666 S.W.2d 640 (Tex.App.—Corpus Christi 1984, no writ)	Holds attorney's fees recoverable in suits for royalty payments under leases.	Applied with Atlantic Richfield to justify awarding attorney's fees to the Gavendas for this deed-reservation-based royalty recovery action.

Court's Reasoning and Analysis

The Court began by explaining the nature and role of division and transfer orders: they direct the distribution of proceeds from oil and gas sales but do not create or alter underlying royalty interests established by deed or lease.

The Court summarized the governing Texas rule: division and transfer orders generally bind underpaid royalty owners until revoked, a rule grounded in the protection of purchasers and operators who rely on division orders and to avoid double liability where the total proceeds paid out are correct but distributive errors occur (i.e., some owners overpaid, others underpaid).

The Court then identified the rationale for an exception to the binding rule: when the operator who prepares erroneous orders retains the benefits of the error and is unjustly enriched, the orders should not bind the royalty owners. The Court relied on the Terrell precedent as controlling authority for that proposition and contrasted it with Middleton, in which the operator did not profit from the error and thus the binding rule was upheld even without detrimental reliance.

Applying these principles to the present facts, the Court found that Strata both prepared the erroneous division and transfer orders and retained at least part of the 7/16ths royalty underpayment for itself — i.e., Strata profited from its error. Because Strata was unjustly enriched, the Court concluded the general binding-until-revoked rule did not apply to the Gavendas.

The Court also addressed Strata's argument that the attorney who made the erroneous title examination was an independent contractor. Citing Wermske, the Court held that the attorney-client relationship establishes an agency relationship such that the attorney's acts and omissions within the scope of employment are attributed to the client; therefore Strata could be held liable for the attorney's negligence. The opinion notes that Strata and Northstar have asserted a third-party cross-action against the attorney.

Finally, on attorney's fees, the Court examined authorities holding attorney's fees recoverable in suits for underpaid royalties arising from leases and found no principled distinction between lease-based and deed-reservation-based royalty suits for purposes of awarding fees; accordingly, the Gavendas may recover attorney's fees under the cited statute.

Holding and Implications

Holding: The Supreme Court of Texas reversed the court of appeals in part and held that the division and transfer orders do not bind any of the Gavendas in this case because Strata erroneously prepared the orders and retained part of the royalties — i.e., Strata was unjustly enriched. The Court further held that attorney's fees are recoverable by the Gavendas.

Implications and direct effects:

The cause is remanded to the trial court to determine: (1) the amount of royalties owed by Strata and Northstar to the Gavendas that were retained by the operators (the total deficiency was undisputed, but the portion actually retained by Strata/Northstar could not be determined from the appellate record); (2) prejudgment interest due on those amounts; and (3) attorney's fees recoverable by the Gavendas under the applicable statute.
Strata is liable to the Gavendas for whatever portion of their royalties it retained as a result of the erroneous orders, but is not liable to the Gavendas for royalty amounts it properly paid out to various overriding or other royalty owners.
The Court attributed the negligent acts of the title attorney to Strata under agency principles, rejecting Strata's independent-contractor defense as framed in the opinion; the opinion notes Strata's third-party cross-action against the attorney remains pending.

This summary reproduces the holdings and reasoning as stated in the opinion. It does not add factual findings beyond those the Court explicitly described; the trial court must quantify the portion of the deficiency retained by Strata and Northstar on remand.

Show full summary ...

John Da v. d GAVENDA et al, Petitioners,

SPEARS, Justice.

This oil and gas case concerns the effect of division and transfer orders. The issue is whether division and transfer orders are binding until revoked when an operator who prepares erroneous orders underpays royalty owners, retaining part of the proceeds for itself. The trial court held the orders were binding until revoked and rendered summary judgment for the operators. The court of appeals affirmed. 683 S.W.2d 859. We reverse the judgment of the court of appeals in part and remand the cause to the trial court.

In 1967, the Gavenda family conveyed land in Burleson County to the Feinsteins. The Gavendas reserved a fifteen-year one-half non-participating royalty interest:

PROVIDED, HOWEVER, the Grantors herein except from this conveyance and reserve unto themselves, their heirs and assigns, for a period of fifteen (15) years from the date of this conveyance, an undivided one-half (1/2) non-participating royalty of all of the oil and gas in, to and under that produced from the hereinabove described tract of land. Said interest hereby reserved is a non-participating

royalty and shall not participate in the bonuses paid for any oil and/or gas lease covering said land, nor shall the Grantors participate in the rentals which may be paid under and pursuant to the terms of any lease with reference to said land.

The Feinsteins later sold the land, subject to the Gavendas' oil and gas reservation, to Billy Blaha. In 1976, Blaha executed an oil and gas lease for a 1/8th royalty.

After various conveyances with overriding royalty interests taken, Strata Energy, Inc. and Northstar Resources, Inc. each acquired a working interest in the lease. They drilled one producing oil and gas well in July, 1979 and another in February, 1980. Strata and Northstar entered into a joint operating agreement naming Strata the lease operator and providing that Strata would disburse all royalties from production. The agreement also provided that Strata's actions were made on behalf of both Strata and Northstar.

Strata hired an attorney to perform a title examination, and he erroneously informed Strata that the Gavendas were collectively entitled to a 1/16th royalty, rather than the actual 1/2 royalty. Following the attorney's erroneous report, Strata prepared the division orders and disbursed the proceeds. When various Gavendas died and royalty ownership changed, Strata prepared and sent transfer orders to the new royalty owners reflecting the same collective 1/16th royalty. The Gavendas signed these division and transfer orders and received the disbursements. The Gavendas were underpaid by 7/16th royalty, 7/16th of gross production, and Strata and Northstar kept at least part of the underpayment.

On discovering this error, the Gavendas on September 29, 1982 revoked the division and transfer orders. Two days later, their royalty interest terminated under the express terms of their reservation. Later in 1982 the Gavendas filed suit to recoup more than 2.4 million dollars in underpaid royalties owed them under the deed reservation.

Both sides filed motions for summary judgment. The trial court and the court of appeals held for Strata and Northstar, maintaining the division orders were binding until revoked. The court of appeals, however, reversed summary judgment and remanded as to Victor Gavenda's estate. The court of appeals held that there were fact issues whether the division and transfer orders encompassed Victor Gavenda's estate.

Both parties have appealed to this court. The Gavendas bring three points of error, contending the rule that division orders are binding until revoked does not apply when there is unjust enrichment, and therefore they should be allowed to recover royalty deficiencies from Strata and Northstar.

Strata and Northstar contend the division and transfer orders were also binding on Victor Gavenda's estate. They, however, do not dispute: (1) the deed reserved a 1/2 royalty, or 1/2 of gross production; or (2) the amount of the royalty underpayment, $2,435,457.51 plus interest. The only issue then is whether under these facts division orders are binding until revoked.

Division orders provide a procedure for distributing the proceeds from the sale of oil and gas. They authorize and direct to whom and in what proportion to distribute funds from the sale of oil and gas. 4 H. Williams, Oil and Gas Law § 701 at 572 (1984). Transfer orders are later changes in the division order's distribution. Id.

In Texas, division and transfer orders do not convey royalty interests; they do not rewrite or supplant leases or deeds. Exxon Corp. v. Middleton, 613 S.W.2d 240, 250 (Tex. 1981); Phillips Petroleum Co. v. Williams, 158 F.2d 723, 727 (5th Cir. 1946). The weight of authority clearly supports this rule. Williams, supra, § 707 at 612.

The general rule in Texas, though, is that division and transfer orders bind underpaid royalty owners until revoked. Exxon Corp. v. Middleton, 613 S.W.2d 240, 250 (Tex. 1981); Chicago Corp. v. Wall, 156 Tex. 217, 293 S.W.2d 844, 847 (1956). One principle underlining this rule is detrimental reliance. 4 H. Williams, supra, § 707 at 614; 3 A. Summers, Oil and Gas § 590 at 139-140 (1958).

Detrimental reliance explains why purchasers and operators are usually protected by the rule that division orders are binding until revoked. In the typical case, purchasers and operators following division orders pay out the correct total of proceeds owed, but err in the distribution, overpaying some royalty owners and underpaying others. If underpaid royalty owners' suits against purchasers and operators were not estopped, purchasers and operators would pay the amount of the overpayment twice — once to the overpaid royalty owner under the division order and again to the underpaid royalty owner through his suit. They would have double liability for the amount of the overpayment. Chicago Corp. v. Wall, 293 S.W.2d 844 (Tex. 1956). Exposing purchasers and operators to double liability is unfair, because they have relied upon the division order's representations and have not personally benefited from the errors.

Generally, the underpaid royalty owners, however, have a remedy: they can recover from the overpaid royalty owners. Allen v. Creighton, 131 S.W.2d 47, 50 (Tex.Civ.App. — Beaumont 1939, writ ref'd). The basis for recovery is unjust enrichment; the overpaid royalty owner is not entitled to the royalties. See 4 Williams, supra, § 707 at 613 (1984); 3 A. Summers, supra, § 590 at 139-40 (1957).

In Exxon v. Middleton, 613 S.W.2d 240 (Tex. 1981), we held the division orders were binding until revoked, even though there had been no detrimental reliance. To provide stability in the oil and gas industry, we held for the distributors of the proceeds because they had not profited from their error in preparing the division order — in short, because there was no unjust enrichment.

In Middleton, Sun and Exxon, the well operators, sold the gas off the premises to purchasers under long term contracts. They then prepared division orders and distributed to the royalty owners a 1/8th royalty based on the contract price. The leases, however, provided for gas sold off the premises for a 1/8th royalty based on market value at the well. The royalty owners sued for their royalty deficiencies — the difference between a 1/8th royalty based on market value at the well and a 1/8th royalty based on contract price.

Exxon and Sun could not have relied on the division orders' representations in making the long-term gas contracts, for they had executed these contracts before the royalty owners had signed the division orders. Id. at 249. More importantly, however, Exxon and Sun did not benefit from the discrepancy between the leases and the division orders. They paid out 1/8th of what they received from the purchaser — 1/8th of the contract proceeds. Moreover, at the time of these transactions, long-term gas contracts were the best arrangement Exxon and Sun could obtain for the royalty owners.

When the operator, however, prepared erroneous orders and retained the benefits, we held that the division orders were not binding. Stanolind Oil Gas Co. v. Terrell, 183 S.W.2d 743 (Tex.Civ.App.-Galveston 1944, writ ref'd). In Terrell, Stanolind Oil Gas prepared the division orders and distributed the bonus and royalty accordingly. Stanolind Oil Gas deducted the gross production tax from the bonus, although the lease provided that there would be no deductions. Despite the lease provision, Stanolind was shifting the gross production tax from itself to Terrell. It was profiting from its own error in drawing up the division order. There was unjust enrichment.

Applying the law to this case, we hold that the division and transfer orders do not bind any of the Gavendas. Strata both erroneously prepared the division and transfer orders and distributed the royalties. Because of its error, Strata underpaid the Gavenda family by 7/16th royalty, retaining part of the 7/16th royalty for itself. It profited, unlike the operators in Exxon v. Middleton, at the royalty owner's expense.

It retained for itself, unlike in Chicago Corp. v. Wall, part of the proceeds owed to the royalty owners. Therefore, Strata is liable to the Gavendas for whatever portion of their royalties it retained, although it is not liable to the Gavendas for any of their royalties it paid out to various overriding or other royalty owners.

Strata also argues that it is not responsible for the loss because the attorney who prepared the title opinions was not Strata's agent but rather an independent contractor. We cannot agree. The attorney-client relationship is an agency relationship. The attorney's acts and omissions within the scope of his or her employment are regarded as the client's acts; the attorney's negligence is attributed to the client. Texas Employers Insurance Ass'n v. Wermske, 162 Tex. 540, 349 S.W.2d 90, 93 (1961). We note that Strata and Northstar have filed a third party cross-action against the attorney.

The Gavendas also request attorney's fees under Tex.Rev.Civ.Stat.Ann. art. 2226 (Vernon Supp. 1985), now codified in the Civil Practice and Remedies Code, ch. 959, § 38, 1985 Tex.Sess. Law Serv. 7123-7124 (Vernon). Attorney's fees are recoverable in suits for royalty payments owed under oil and gas leases. Atlantic Richfield Co. v. Manges, 702 F.2d 85, 87 (5th Cir. 1983); Gerdes v. Mustang Exploration Co., 666 S.W.2d 640, 645 (Tex.App. — Corpus Christi 1984, no writ). Because we see no distinction between allowing attorney's fees on underpaid royalty suits based on leases and those based on deed reservations, we hold the Gavendas can recover their attorney's fees.

We reverse the judgment of the court of appeals in part and remand the cause to the trial court to determine the amount of royalties owed by Strata and Northstar to the Gavendas, prejudgment interest due thereon, and attorney's fees. Although the total amount of the royalty deficiency is undisputed, we cannot tell from the record what portion of the royalty deficiency was retained by Strata and Northstar.

GAVENDA v. STRATA ENERGY INC