Carlson v. Flocchini Investments

Flocchini Investments and others (collectively, the mineral owners) (defendants) purchased surface and mineral interests in a ranch, including the executive right to lease the minerals. C. E. Carlson and others (collectively, the royalty owners) (plaintiffs) purchased a royalty interest in the minerals. In 1982, the royalty owners and mineral owners agreed that the mineral owners would negotiate all future mineral leases in good faith and as ordinary prudent mineral owners. The agreement also provided that if the mineral owners acquired an overriding royalty interest in the subject ranchland, that royalty would be split among the mineral owners and the royalty owners. In 1994, Petrox Resources, Inc. (Petrox) expressed interest in producing methane gas from the ranch. Durham Ranches, Inc. (Durham), which had acquired part of the surface estate, was concerned about the effects of coalbed-methane development on the ranchland. A. J. Flocchini, Jr. (Flocchini) was in charge of negotiating mineral leases on the mineral owners’ behalf and surface-use agreements on Durham’s behalf. Although Petrox initially offered a 16-percent or 16-and-2/3-percent royalty, Flocchini and Petrox eventually agreed that the mineral owners would lease the minerals to Petrox for a 15-percent royalty and Petrox would pay $50,000 to compensate Durham for the surface use, plus $1,000 per producing well and a 3-percent overriding royalty interest. Durham did not share the 3-percent overriding royalty interest with the royalty owners. The royalty owners sued the mineral owners for breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty, claiming that the royalty owners were entitled to share in the overriding royalty interest and that Flocchini had engaged in self-dealing in negotiating with Petrox. The trial court entered judgment for the mineral owners on the breach-of-contract claim, concluding that the 1982 agreement required the split only of overriding royalties acquired by the mineral owners, and Durham was not a mineral owner. The court also found that Flocchini, as holder of the executive right to lease the minerals, was required to meet the good-faith and ordinary-prudent-mineral-owner standards established in the 1982 agreement. The trial court found that Flocchini had negotiated and executed reasonable and fair mineral leases with Petrox and that ordinary prudent mineral owners would have negotiated the same lease terms. The court thus concluded that Flocchini had fulfilled his duties to the royalty owners. The royalty owners appealed, arguing, among other things, that the trial court had applied the wrong standard to measure Flocchini’s conduct.