On June 2, 2017, the Louisiana Court of Appeal for the Second Circuit rendered a decision in Gloria’s Ranch, LLC v. Tauren Exploration, Inc., Cubic Energy, Inc., Wells Fargo Energy Capital Inc., and EXCO USA Asset, Inc., 2017 WL 2391927, ___ So. 3d ___, reh. denied, which should cause serious concern for lenders to oil and gas lessees. It held a lender (Wells Fargo) liable with its borrower, a mineral lessee for significant damages (over $23 million) for failure to release a mineral lease in which Wells Fargo held no working interest.
The factors the court considered in imposing solidary liability (liability for the entirety of the debt with other debtors) on the lender are cause for concern in light of provisions of sophisticated lending instruments.
Wells Fargo lent money to Cubic Energy and Tauren Exploration. Cubic entered into a credit agreement with Wells Fargo that involved a mortgage and collateral assignment of Cubic’s interest in the mineral lease from the ranch. As a part of the credit agreement, Wells Fargo had the right to approve the location depth of wells and the right to access the property. The credit agreement also required Cubic to provide quarterly and annually financial statements as well as sales and production reports to Wells Fargo. Wells Fargo had to consent to any transfer of the lease or release of the lease by Cubic. In subsequent transactions, Wells Fargo obtained an overriding royalty interest and a net profits interest in profits from the lease.
The lessor made demand on all the interest owners in the lease, including Wells Fargo, for a release. Neither Cubic nor Wells Fargo complied with the demand. The lessor sued Cubic, Wells Fargo, and others for damages for failure to release the lease. The significant damage item was the lost opportunity to lease the land to another. The original lease occurred in 2004, and the demand for release happened during the Haynesville Shale boom in North Louisiana, so that the court assessed damages at $18,000.00 per acre for over 1,390 acres.
The Court of Appeal apparently was persuaded by the elements of control that Wells Fargo had the right to exercise with respect to Cubic. It specifically mentioned the “bundle of rights” that was part of the credit facility. Lenders should be particularly concerned because in most commercial loans, provisions about approval of certain operations, the provision of quarterly and annual financial statements, and other reports of sales and production are common. In addition, most loan agreements restrict the borrower’s ability to transfer or release collateral without the lender’s consent.
The panel clearly recognized that it was stretching existing law, and it attempted to limit the effect of its decision, stating, “We note this case is highly fact-intensive and should not be construed as governing other cases that may follow unless the same facts exists.”
The court’s statement is cold comfort to lenders. Similar facts likely will exist not only in oil and gas credit agreements, but also in other commercial loan transactions. What is the tipping point for the “bundle of rights” that could result in lender liability? How is a lender to predict what it ought to do in terms of changing its loan documents to avoid liability to third party?
In a real sense, this case actually represents a worse development for lenders than the lender liability cases of the late 1980s and early 1990s. In those cases, the lenders primarily were being held liable to their borrowers. This case holds a lender liable to a third party with its borrower.
Imagine the dilemma that Wells Fargo was in. If it executed a release, and it turned out that the lease had not expired, its borrower, with whom the lender has a contractual relationship, might complain that the lender had damaged its ability to argue that the lease was still in effect. If it failed to release, then it faces liability to the third party. There may be no safe course of action for the lender under these circumstances.
In his dissent from the denial of rehearing, former Louisiana Supreme Court Associate Justice Joe Bleich, sitting ad hoc, pointed out the risks to which the opinion exposes lenders, as well as the potential chilling effect the result could have on oil and gas lending in Louisiana.
This is a case to watch.
M. Thomas (Tom) Arceneaux is a director with the firm of Blanchard, Walker, O’Quin & Roberts in Shreveport. He has been a member of the firm’s executive committee since 2004. Tom has a substantial practice in business law, including both transactions and litigation, as well as in state and local government law, including representing public and private clients in zoning and land use matters, open meetings, procurement, and public records issues. He is also a qualified mediator in Louisiana and Texas. Tom received his B.S. in economics, magna cum laude, from L.S.U. in Baton Rouge in 1972 and his J.D. from the L.S.U. Law Center in 1976. Tom is a member of the Louisiana and Texas State Bar Associations and the American Bar Association. He is admitted to practice before state courts in Louisiana and Texas, as well as the United States District Court for the Western District of Louisiana, the United States Fifth Circuit Court of Appeals, and the Supreme Court of the United States. He is a master member and team leader of the Booth-Politz American Inn of Court.