Opinion ID: 895065
Heading Depth: 1
Heading Rank: 4

Heading: Must Sheppard Pay Drilling Costs?

Text: Sheppard concedes that once her lease expired, she must pay her share of expenses to produce and market gas thereafter. [26] But she argues, and the courts below agreed, that she did not have to pay any of the drilling or other costs incurred before the lease expired. [27] But the general rule regarding improvements is otherwise: The principle is well established in equity that a person who in good faith makes improvements upon property owned by another is entitled to compensation therefor. [28] Thus, when a son lost a farm because his deed from his father was oral, we held he might still seek reimbursement for improvements he built to the extent they enhanced the farm's value. [29] When a couple used community funds to build a home on realty owned separately by one spouse, we held the community estate had an equitable right of reimbursement for the improvements. [30] And when a co-tenant paid to raise a lot in Galveston above sea-level, we held he was entitled to reimbursement of his costs. [31] As we explained in the latter case, this rule arises in equity: When two persons are cotenants in the ownership of land, and one of them incurs expense in the improvement of the property which is necessary and beneficial, it is equitable that the one incurring the expense shall have contribution from his cotenant in an amount which is in proportion to the undivided interest owned by such cotenant.... The law implies a contract between him and his cotenant, authorizing him to spend for him the money which was necessarily spent.... [32] Under Texas law, only a naked trespasser cannot recover for improvements that benefit another's land. [33] As oil and gas wells are improvements to real property, [34] the same rule applies to them: one who drills a well in good faith is entitled to reimbursement. [35] This rule applies even if an operator's lease is not valid, so long as the operator believed in good faith that it was. [36] Similarly, a co-tenant who drills without another co-tenant's consent is entitled to reimbursement: It has long been the rule in Texas that a cotenant has the right to extract minerals from common property without first obtaining the consent of his cotenants; however, he must account to them on the basis of the value of any minerals taken, less the necessary and reasonable costs of production and marketing. [37] Thus, there is no question that under Texas law Wagner & Brown could have recovered a share of drilling costs from Sheppard had she signed no lease at all. The question is whether the rule should be different because there was a valid lease that was mistakenly allowed to expire. It is of course true that equity does not favor those who sleep on their rights. [38] But it is hard to see why one who obtains a lease and then loses it by mistake is entitled to less equity than one who by mistake never had a valid lease in the first place. It is true that C.W. Resources breached Sheppard's lease, but a breaching party is not necessarily barred from reimbursement for improvements. For example, Texas law permits recovery to builders upon substantial performance, even if they have breached their building contract. [39] As we have explained, this rule is based on the owner's acceptance and retention of the benefits arising as a direct result of the contractor's partial performance. [40] Beyond these general principles, the parties assert that several cases establish rules in their favor, but we find none convincing. The closest are two 1965 opinions by the Seventh Court of Appeals. In Thoreson v. Fox, the court found that a lease had expired for failure to commence production within 120 days, but nevertheless allowed the operator to recover its drilling costs from amounts it owed for gas sales. [41] After quoting a Pennsylvania Supreme Court case allowing reimbursement to an operator who mistakenly drilled on the wrong lease, the Seventh Court stated: Surely, if a trespasser, as in the Pennsylvania case just cited, is entitled to recover for the cost of drilling and for machinery and appliances incident to the operation of the well[,] defendants here would be entitled to recover for the value of the improvements to the land itself, limited to the actual cost to the defendants. [42] Less than three months later, the same court refused to allow reimbursement in Steeple Oil & Gas Corp. v. Amend , in which a lease terminated for failure to pay shut-in royalties. [43] The court distinguished Thoreson on two grounds: (1) the mineral owner in Thoreson invoked equity by seeking an order barring removal of casing and equipment, and (2) a jury found the Thoreson operator had acted in good faith. [44] While in some jurisdictions reimbursement for a builder may depend on an equitable counterclaim by the owner, [45] that does not appear to have been the general rule in Texas. [46] Nor is it clear why the failure to pay shut-in royalties in Steeple was not in good faith while the failure to commence timely production in Thoreson was. In any event, both opinions were promptly reversed by this Court on other grounds. [47] Almost 80 years ago, the Commission of Appeals held in Broadway v. Stone that a plaintiff who bought an unleased 1/36th mineral interest after four producing wells had been drilled was chargeable in equity with a proportionate part of the reasonable value of said improvements. [48] While the Commission said that production after the plaintiff's purchase should be reduced by expenses incurred after that date, it also held that such production was subject to the charge for improvements made before that date. [49] But as Broadway did not involve a terminated lease, and was approved by this Court only as to its holding rather than its reasoning, [50] it is not controlling here. [51] One cannot conclude much from this limited set of cases, except that operators apparently do not let many productive leases expire before recovering their drilling costs. Given the equitable nature of a reimbursement-for-improvements claim, [52] we decline to read Texas law as establishing that drilling costs are always or never recoverable when a lease expires. Instead, we believe the equitable nature of such claims must turn on the equities in each case. Thus, for example, an operator who intentionally terminates a lease has a weaker claim to equity than one who does so by accident. One who immediately offers to reinstate an expired lease has cleaner hands than one who does not. As with other equitable actions, a jury may have to settle disputed issues about what happened, but the expediency, necessity, or propriety of equitable relief is for the trial court, [53] and its ruling is reviewed for an abuse of discretion. [54] Based on the summary judgment record here, it appears that the trial court abused its discretion in refusing reimbursement of drilling costs. There is no question Sheppard's tract has enjoyed ten years of production from two gas wells drilled at the sole risk and expense of the defendants. Neither well was drilled by a trespasser; the defendants had title to the other 7/8ths of the minerals on her tract, and thus an unquestionable right to drill the wells where they were. Sheppard had the option to continue collecting royalties free of any drilling costs, as Wagner & Brown offered to reinstate her lease on that basis. Having chosen instead (as was her right) to be a co-tenant with full benefits to the minerals she owned, it would be inequitable to allow her to escape the burdens that come with that choice. Further, it is well-settled that equity abhors forfeiture. [55] Consistent with that rule, Texas law requires that in construing mineral leases doubts should be resolved in favor of a covenant instead of a condition so that forfeiture is avoided. [56] Sheppard's lease leaves no room for doubt that the operators forfeited the lease when the first royalty was delayed; but it says nothing about whether they forfeited drilling costs too on that basis. While the defendants lost forever their legal claim to Sheppard's minerals, that does not necessarily mean that they also lost their equitable claim for the improvements they had built on her tract. Again, equity might deny such a claim had the lease expired long after production had begun and the operators had recovered most of their drilling costs. But the lease here terminated at the very outset of production, so denying reimbursement would work a substantial forfeiture. Under the facts in the record here, the trial court abused its discretion by allowing Sheppard to reap all the proceeds of production without bearing any of the costs. The court of appeals denied reimbursement on the basis that Sheppard was a royalty owner at the time drilling costs were incurred, and thus was not liable for them. [57] But Sheppard ceased being a royalty owner shortly after production began. To the extent working interest owners paid drilling costs out of production over the following months, Sheppard too would be liable for those costs as she became a working interest owner after her lease terminated. [58] Because of the absence of authoritative caselaw, the evidence presented in the parties' cross-motions for summary judgment did not focus on the equitable issues like those we have indicated above. We recognize there might be other facts not appearing in the record that would justify denying Wagner & Brown an equitable right of reimbursement for drilling or other pre-termination costs. Accordingly, in the interest of justice we reverse the court of appeals' judgment and remand the case to the trial court for further proceedings consistent with this opinion. [59]