Texas appellate court rules that mineral leases with municipalities are worth more than the paper they are written on

On February 7, 2017, a Texas appellate court ruled that the city of Dallas must face a $200 million lawsuit filed back in 2014, where a driller alleged that the city acted improperly by entering into a mineral lease with the company and then denying it permits to drill—effectively rendering the lease worthless. See City of Dallas v. Trinity East Energy, LLC, No. 05-16-00349-CV (Tex. App.- Dallas Feb. 7, 2017).  Dallas had argued that it was immune from suit because it was acting in a governmental function when it entered into the lease; however, the court held that the city was actually acting in a proprietary function and therefore was not immune.

Trinity East Energy, LLC signed a mineral lease with the city to drill for oil and gas, but then the city of Dallas refused to approve Trinity’s applications for permits to drill. Trinity in turn sued for breach of contract and inverse condemnation.  As the court in City of Midlothian v. Black, 271 S.W.3d 791 (Tex. App.- Waco 2008), explained, “inverse condemnation” occurs when “a governmental entity physically appropriates or invades the property, or when it unreasonably interferes with the landowner’s right to use and enjoy the property, such as by restricting access or denying a permit for development.”  Dallas maintained that it was immune from suit.  The district court agreed, finding that the city was immune and thus beyond the reach of the court.

The appellate court reversed, in part, and rejected Dallas’s immunity arguments based on recent Texas Supreme Court precedent in Wasson Interests, Ltd. v. City of Jacksonville, 489 S.W.3d 427 (Tex. 2016) that “sovereign immunity does not imbue a city with derivative immunity when it performs proprietary functions.  This is true whether a city commits a tort or breaches a contract, so long as in each situation the city acts of its own volition for its own benefit and not as a branch of the state.”

Dallas attempted to argue that these transactions were an exercise of its governmental functions in the regulation of parks, floodplains, building codes and inspections when it entered into the leases and that the grant or denial of a specific use permit is a zoning change- a governmental function. But the court held that the conduct at issue clearly implicated Dallas’s proprietary function because the actions were taken not for the benefit of the entire state, but rather for the benefit of only those who live within the city’s corporate limits.  As a result, the city was not immune from suit.  However, the court also concluded that “even if the City was acting in its governmental capacity, Trinity alleged a viable claim for inverse condemnation.”

This decision will likely provide a good measure of comfort to drillers in the Texas area who take leases from municipalities. If this decision is left to stand, drillers should have comfort that cities cannot pull the rug out from under them and leave them holding a worthless lease that cannot be worked.  And while Dallas may be reeling from this decision, in the long-run it might actually be to its benefit.  If drillers had to worry that they would be left without recourse after leases from cities were nullified by their failure to issue permits, it is likely that the market for such leases would dry up, or at least become way less attractive.  We will keep you posted on whether the Texas Supreme Court decides to take up this issue.

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