The Oil and Gas Addendum

The calculation of production royalties and the deduction of post-production costs remains a controversial topic here in Pennsylvania. As we have written before, there is another frustrating and often confusing royalty-related issue which can, and does, impact landowner royalties. (See, Federal Court in Pittsburgh Rules That 1897 Deed Did Not Grant A Non-Participating Royalty Interest – November 18, 2021).  For example, assume you sign an oil and gas lease in 2022 with ABC Drilling regarding your 145 acre farm in Tioga County. You spend weeks negotiating the lease and eventually agree on a 18% royalty clause. In April 2023, you receive your first royalty statement from ABC Drilling. Much to your surprise, the royalty is not calculated on 18% but rather 9%. You are shocked, angry and confused. ABC Drilling informs you that back in 1920, your great-grandfather conveyed a fifty percent (50%) royalty interest to Mr. Bowers, a person you never heard of. The representative from ABC Drilling tells you that, pursuant to the 1920 Deed, it is paying one-half of the 18% royalty in Mr. Bowers’ grandchildren.

You do some research and obtain a copy of the 1920 Deed. The instrument says that your great-grandfather conveyed to Mr. Bowers “one-half of one-eighth of all oil and gas produced from the land.” You contact ABC Drilling and inform them that they simply did the math wrong. At best, the heirs of Mr. Bowers only acquired 1/16^th interest (i.e. 1/2 x 1/8 = 1/16). ABC Drilling says you are wrong and refers to something called the “estate misconception theory.” You are incensed. How can a remote transaction in 1920 unilaterally reduce your current royalty in half?  And how can 1/2 x 1/8 equal 1/2 ? This double-fraction issue is rather common in older oil and gas deeds and unfortunately affects many landowners each year here in Pennsylvania. Recently, the Texas Supreme Court addressed this double-fraction issue in Van Dyke v. The Navigation Group, et al and provided some much needed clarity to this confusing area of oil and gas law.

At issue in Van Dyke was a 1924 deed whereby George and Frances Mulkey (“Mulkey”) conveyed their 424 acre ranch in Martin County, Texas and the underlying oil and gas rights to G.R. White and G.W. Tom ( “White/Tom”) The 1924 Deed contained the following reservation:

“It is understood and agreed that one-half of one-eighth of all minerals and mineral rights in said land are reserved in grantors, Geo. H. Mulkey and Frances E. Mulkey and are not conveyed herein”

For ninety (90) years after the 1924 Deed was executed, both parties, and their subsequent heirs and assigns, engaged in multiple transactions and leases suggesting that each side owned ½ of the underlying oil and gas estate.  In 1973, the heirs and successors of Mulkey and the heirs and successors of White/Tom entered into a new oil and gas. Again, each side acknowledged that the other side owned fifty-percent of the oil and gas estate underlying the ranch. In 2012, the lessee, Endeavor Energy, drilled a well on the ranch. Shortly thereafter, the successors of White/Tom brought an action against the successors of Mulkey after Endeavor Energy decided to pay the production royalties equally to both parties (i.e. 50/50). At stake was $44 million in accumulated production royalties.

The successors of White/Tom asserted that the double-fraction in the 1924 Deed was nothing more than an elementary arithmetic formula and that nothing else should be read into the clause. Under their interpretation, Mulkey only reserved a 1/16^th interest. (i.e. 1/8 x 1/2 = 1/16).  Conversely, the Mulkey successors argued that at the time the 1924 Deed was drafted, the double-fraction was a “term of art” that had a specific and well-known meaning. According to the Mulkey successors, the double-fraction reflected an intent to reserve one-half of the landowner’s oil and gas estate. Since most oil and gas leases at that time only reserved a 1/8^th royalty, it was assumed in the 1920’s and 1930’s that the overall “interest” owned by the landowner was always 1/8^th.  As such, a conveyance of “one half of one-eighth” would mean that the parties intended to convey one-half of the landowner’s entire oil and gas estate. The Mulkey successors further argued that, under the presumed-grant doctrine, even if the 1924 Deed initially reserved only a 1/16^th interest, the ninety years of subsequent conduct by both parties established 50/50 ownership.

In 2018, the trial court granted summary judgment in favor of the White/Tom successors opining that the 1924 Deed conveyed a 15/16^th interest to White/Tom. The successors of Mulkey then filed an appeal to the Eleventh Court of Appeals. The Eleventh Court of Appeals affirmed and rejected the Mulkey successors’ argument that the so-called “estate misconception theory” applied to the 1924 Deed. Under this theory, modern courts must construe the double-fraction in light of the mistaken belief held by most landowners in the 1920’s and 1930’s that they only owned 1/8^th of the oil and gas after a lease was signed. See, Garrett v. Dils Co., 299 S.W.2d 904 ( Tex. 1957) (“the usual royalty provided in mineral leases [during that era] is one-eighth”); WTX Fund LLC v. Brown, 595 S.W. 3d 285 ( Tex App- El Paso 2020)( noting that the theory refers “to a once-common misunderstanding that a landowner retained only 1/8^th of the minerals in place after executing a mineral lease instead of a fee simple determinable with a possibility of reverter…”); Graham v. Prochaska, 429 S.W. 3d 650 (Tex. App. – San Antonio 2013) (“[T]he historical standardization of the landowner’s royalty at 1/8 of production has sometimes created confusion in the construction of deeds from that time period …”) .  The Eleventh Court of Appeals opined that the theory was inapplicable because there was no lease in effect at the time the 1924 Deed was executed:

We also note that the estate misconception theory, as relied upon by the Mulkey Assignees, is built upon the principle that mineral owners in the era in which this deed was executed assumed that, after they had executed an oil and gas lease, they retained only a one-eighth interest in the minerals.  The Mulkeys could not have been operating under the estate misconception theory because, at the time of the deed, they owned all the attributes of the mineral estate; there was no lease of the minerals and there had been no conveyance of any part of the bundle of sticks that make up mineral and mineral rights ownership—the Mulkeys owned it all.   

The Eleventh Court of Appeals also rejected an application at the presumed grant doctrine.  Under this doctrine, a landowner can establish title to oil and gas rights by circumstantial evidence.  However, the Eleventh Court of Appeals held that the doctrine was inapplicable because there was no “gap” in the chain of title.  See, Seddon v. Harrison, 367 SW 2d. 888 (Ter App-Houston 1963) (grant could not be presumed because there was no “missing link” in appellant’s chain of title); Howland v. Hough, 570 S.W. 2d 876 (Tex. 1978) (grant presumed where plaintiff’s chain of title showed continuous recorded conveyances except a gap between 1845 and 1878).  Because the Mulkey successors traced their title to the 1924 Deed and that instrument expressly reserved “one half of one eighth,” the doctrine could not be used to contradict or change the scope of that reservation.  The Mulkey successors appealed to the Texas Supreme Court in 2021.

In a much anticipated opinion, the Texas Supreme Court issued its ruling on February 17, 2023, reversing the Eleventh Court of Appeals.  First, the panel recognized the viability of the estate misconception theory and observed:

“ . . .  for many years lessors would refer to what they thought reflected their entire interest in the mineral estate with a simple term they understood to convey the same message: 1/8”

Second, the Supreme Court rejected the Eleventh Court of Appeal’s notion that the theory can only apply if there was an oil and gas lease in place when the subject instrument was executed.  Third, the Texas Supreme Court ruled that, given the “widespread and mistaken belief” that landowners thought they only owned a 1/8^th interest, the use of such double-fractions in historical deeds will give rise to a presumption that the grantor was referring to the entire oil and gas estate:

“ …. When courts confront double-fraction involving 1/8 in an instrument, the logic of our analysis …. requires that we begin with a presumption that the mere use of such a double-fraction was purposeful and that 1/8 reflects the entire mineral estate, not just 1/8 of it”

In other words, the Texas Supreme Court essentially concluded that any time a historical deed references, a 1/8^th interest, Texas law will now recognize that fraction as representing the entirety of the landowner’s oil and gas estate.  Prior cases in Texas were unclear as to the weight such language was entitled when reviewing historical deeds.  After Van Dyke, the test is now clear: the presence of such a term will give rise to a rebuttable presumption, which can only be rebutted by language in the deed itself suggesting a contrary intent.  Since the 1924 Deed did not contain any language rebutting this presumption, the Texas Supreme Court opined that the 1924 Deed “did not use 1/8 in its arithmetical sense but instead reserved to the Mulkey successors a ½ interest” in the underlying oil and gas estate.

Finally, the Van Dyke court observed that even if the estate misconception theory did not apply, the Mulkey successors’ would nonetheless own a ½ interest by virtue of the presumed grant doctrine.  The panel noted that the doctrine requires a proponent to establish three (3) elements: i) a long-asserted ownership claim adverse to the apparent owner; ii) non-claim by the apparent owner; iii) acquiescence by the apparent owner.  If the proponent establishes all three elements, Texas law permits an inference that the apparent owner has, in fact, conveyed his interest to the proponent.  The Eleventh Court of Appeals, however, had imposed an additional fourth element:  a gap in the record title. (i.e. missing deed that was never recorded).  The Texas Supreme Court rejected this additional element and concluded that the Mulkey successors had established ninety years of acquiescence and that such evidence was sufficient to demonstrate a “presumed grant” of a fifty percent (50%) interest.

Although the Van Dyke decision is not binding on Pennsylvania courts, the logic and rationale espoused by the Texas Supreme Court could impact the interpretation of historical deeds with double-fractions here in Pennsylvania.  The practical effect of the Van Dyke opinion remains unclear.  In one sense, the opinion creates an objective presumption in favor of the estate misconception theory and directs courts to treat the 1/8 designation as referring to the entire oil and gas estate.  On the other hand, the opinion suggests that this same presumption can be negated by decades of conduct under the presumed grant doctrine.  Either way, confusion and litigation arising out of the double-fraction is bound to continue.  If you have a deed with a double-fraction in your chain of title, it is worth having an experienced oil and gas attorney review the original instrument to determine if the royalty reservation is being properly interpreted and calculated.