October 2017 Legal Update by Patrick S. Ottinger/Ottinger Hebert

by: Martha Mills at 9/25/2017 9:40:54 AM | Viewed 284 times.

Liability of Mortgagee-Bank for Faults

of its Mortgagor-Borrower

 

Patrick S. Ottinger

Ottinger Hebert, LLC

Adjunct Professor of Law, Paul M. Hebert Law Center,

Louisiana State University, Baton Rouge, Louisiana

 

                    The case we review this month is admittedly a bit different (certainly not “run of the mill”), but it is unquestionably one of the most significant and controversial decisions rendered by a Louisiana appellate court in many decades.  The case is “a bit different” in the sense that one working in the land business might only find a bit or snippet of relevant information in a few places in the case.  It is significant and controversial because it has the potential of resulting in a retreat in capital markets that loan money to E&P companies, and, consequen­tially, a further reduction in the number of wells drilled.  The case is not final, but is worthy of understanding at this stage of the proceeding.

 

                    In Gloria’s Ranch v. Tauren Exploration, Inc.,[1] the Second Circuit, Court of Appeal, affirmed a trial court’s decision that held a mortgagee liable, on a solidary basis,[2] with its lessee who had been cast for “over $23,000,000 in monetary awards and close to $1,000,000 in attorney fees.”[3]  The mineral lessee, Cubic Energy, Inc., was held liable for damages because it failed to timely release a mineral lease,[4] that the court held to have expired for failure to produce “in paying quantities.”[5]

 

                    Under article 207 of the Louisiana Mineral Code, if the “former owner of the . . . expired mineral [lease] fails to furnish the required act [evidencing the termination of the mineral lease] within thirty days of receipt of the demand . . ., he is liable to the person in whose favor the . . . lease has been . . . expired for all damages resulting therefrom and for a reasonable attorney’s fee incurred in bringing suit.”[6]

 

                    In this case, the mineral lease having been determined to have lapsed, the damages were based upon $18,000 per acre—the “going rate” in the Haynesville Shale in Northwest Louisiana at the time of lease termination—for “lost leasing opportunities.”[7]

 

                    Whatever can be said about the propriety of the court’s determina­tion as to lease termination, and the basis of damages “resulting from” the failure to timely release the expired lease, the most radical aspect of the decision is that the mortgagee-lender of the lessee was held liable along with the defaulting lessee.

 

                    The trial court based its decision principally on the fact that the mortgagee, under its mortgage, had been “assigned” the mineral lease, seem­ingly making the mortgagee a working interest owner for purposes of having a statutory duty to release an expired mineral lease that constituted its collateral.[8]  The mortgage clause on which the trial court relied was an assignment of proceeds, commonly found in mortgages encumbering the working interest in the leases.[9]

 

                    The good news is that the appellate court reversed that particular finding as a basis of liability.  The bad news is that the appellate court found that the various covenants in the recorded mortgage and unrecorded credit agree­ment—typical in “reserve based lending” transactions of this type—evidenced elements of “control” sufficient to impose liability on the mortgagee. 

 

                    Most important to the court seemed to be a mortgage provision that required the bank’s consent to the release by the lessee of an item of collateral, in this case, a mineral lease.  As to this common clause, the court noted, as follows:

 

Wells Fargo exercised control over Cubic’s oil and gas operations on the lease, and controlled Cubic’s ability to release the lease for failure to produce in paying quantities.  As such, Wells Fargo shared coex­tensive liability with Cubic to provide a recordable act evidencing the release of its interest in the lease, and we discern no manifest error in the trial court finding Wells Fargo solidarily liable with the remaining defendants.[10]

 

                    The court’s analysis, if it can be said to exist at all, is thin, to say the very least.  The decision does not articulate a rational basis on which the bank’s liability for monetary damages was imposed for the actions or inactions of its borrower.  No prior case has turned a lending party into essentially a surety or guarantor of its borrower.  The various covenants on which the court relied to find the elements of “control” are typical in virtually every credit facility in the E&P lending space, and are in fact encouraged by Federal regulations and lending guidelines.

 

                    The foreseeable adverse implications of this decision were correctly noted by Judge Bleich, sitting pro tempore, and joined by Chief Judge Brown, who “strongly agreed” with the dissenting reasons of Judge Bleich on rehearing denial.  As cogently recognized by Judge Bleich:

 

Devastating economic repercussions might possibly develop throughout the lending industry if the original opinion of this court is maintained.  Serious and harmful impact on the oil and gas industry is foreseeable.  At a minimum, confusion will develop inside the legal community, as well as to other advisors to the respective companies within those industries if the original pronouncement of this court is maintained.  Notwithstanding a generally well written and analyzed original opinion and the instructive language therein that this is a somewhat isolated fact setting, cautious managers and decision makers within those industries will incur a most chilling effect on their businesses.  All of these developments can be potentially harmful in a broader sense; e.g. the potential impact on the financial condition of this state resulting from lost revenue.[11]

 

                    If this radical decision is correct (and this author does not believe it to be), banks should be concerned that the same result might attach if the borrower-mineral lessee is found liable for a “legacy lawsuit,” damages for personal injury or death, failure of the operator to pay bills to contractors, or other fault or liability of the borrower-lessee. 

 

                    To be sure, even beyond the energy lending space, a commercial lender in a sophisticated transaction typically enjoys an array of covenants that might be characterized as elements of “control,” potentially leading to unantici­pated responsibility for a fault of its borrower.

 

                    Beyond the important topic of the liability of a bank for the faults of its borrower, other issues presented in the case include the issue of whether a court is authorized to award “treble” or only “double” the amount of royalties due as damages for nonpayment of royalties, finding a lessee solidarily liable for damages related to an interest which it did not own, and the amount of attorney’s fees awarded ($1,061,803).

 

                    Wells Fargo filed an application for rehearing that was denied on August 7, 2017, with two blistering dissents, as partially noted above.  The defendants (Wells Fargo, Cubic and Tauren) filed applications with the Louisiana Supreme Court on September 6, 2017, seeking review by that court.  The case is not final, and bears watching as it proceeds.[12] 

 

 



[1]         2017 WL 2391927 (La. App. Ct. 2d 2017).

[2]         Parties cast as being “solidarily liable” means that each party can be held liable for the whole of the monetary obligation, and the creditor is not required to pursue each party separately for its actual share.

[3]         Id. at *1.

[4]         Article 206 of the Louisiana Mineral Code.

[5]         Article 124 of the Louisiana Mineral Code.

[6]         Article 207 of the Louisiana Mineral Code.

[7]         See Patrick S. Ottinger, Louisiana Mineral Leases:  A Treatise, § 1-25(e) (Claitor’s Law Books & Publishing Division, Inc., 2016), for a discussion of volatility in bonus prices in the Haynesville Shale in Northwest Louisiana in the year 2008, documenting per acre bonus payments ranging from $150 (February 2008) to $25,000 (July and August 2008).

[8]         The absurdity of this finding would be that the mortgage would have been extinguished by “confusion” (Louisiana’s version of the doctrine of “merger”).

[9]         This typical mortgage provision read, thusly: 

          2.03 Assignment.  To further secure the full and punctual payment and performance of all present and future Indebtedness, up to the maximum amount outstanding at any time. . . . Mortgagor does hereby absolutely, irrevocably and unconditionally pledge, pawn, assign, transfer and assign to Mortgagee all monies which accrue after 7:00 a.m. Central Time . . . to Mortgagor’s interest in the Mineral Properties and all present and future rents therefrom . . . and all proceeds of the Hydrocarbons . . . and of the products obtained, produced or processed from or attributable to the Mineral Properties now or hereafter (which monies, rents and proceeds are referred herein as the “Proceeds of Runs”). Mortgagor hereby authorizes and directs all obligors of any Proceeds of Runs to pay and deliver to Mortgagee, upon request therefor by Mortgagee, all of the Proceeds of Runs . . . accruing to Mortgagor’s interest[.]

[10]        2017 WL 2391927 at *33.

[11]        Dissent in the Denial of Rehearing, p. 1.

[12]        In the interest of full disclosure, this author submitted an amicus curiae (“friend of the court”) brief with the Louisiana Supreme Court on behalf of the American Bankers Association and the Texas Bankers Association, in support of the writ application filed by Wells Fargo.

 

Pat Ottinger is a partner in Ottinger Hebert, L.L.C., where he has practiced oil and gas law since 1974.  He is a graduate of the Paul M. Hebert Law Center at Louisiana State University.  He is licensed to practice in Louisiana and Texas.  Since 1996, he has taught the course in Mineral Rights at the Paul M. Hebert Law Center.  He is the author of A Course Book on Louisiana Mineral Rights, utilized at three law schools in the state.  He published a comprehensive work on mineral leases, entitled Louisiana Mineral Leases:  A Treatise, available through claitors.com and amazon.com.  He is an experienced mediator and arbitrator, rendering such services through The Patterson Resolution Group.  He currently serves as Chair of the Advisory Council of the Mineral Law Institute at LSU.  He is a member of the Mineral Code Committee, Prescription Committee, Counter-letter Committee, Unsolicited Offers Committee, and Tax Sales Committee, and is Reporter for the Risk Fee Act Committee of the Louisiana State Law Institute.  He is a Past President of the Louisiana State Bar Association, and served as Chair of the Mineral Law Section of that association.  He served as City-Parish Attorney of Lafayette Consolidated Government from January 2004 to February 2011.

 

 

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