Oil and Gas Executive Rights – Drilling Down on Your Duty

3 minute read

By:  Ted R. Harrington

He who has the gold makes the rules. However, when the “gold” includes oil and gas executive rights (the ability to lease, or not lease, a mineral interest), the rule-maker does not have unfettered discretion, especially when decisions appear to stem from self-interest. Over the past decade, the Texas Supreme Court has attempted to define and clarify exactly what duty is owed by an oil and gas executive right holder (the “executive”) to the non-participating interest holders who are along for the ride, collecting royalty payments but having little to no ability to control how they are generated. While the executive right holder does not owe a fiduciary duty to non-participating royalty interest (“NPRI”) holders (those royalty holders who do not share in bonus or rental payments and who also do not have the right to execute leases), it is clear that a certain level of consideration is required, and the failure to do so may be costly.

The first substantial step the Texas Supreme Court took towards pinning a duty on executives came in 2011, in Lesley v. Veterans Land Bd. of State. The Court in this case dealt with an executive’s inaction, or refusal to lease, and stopped short of producing a bright-line test for holding executives accountable. Instead, it toed the line and put forth the idea that if the executive’s refusal to lease was “arbitrary or motivated by self-interest, the executive may have breached his duty.” Lesley v. Veterans Land Bd. of State, 352 S.W.3d 479, 491 (Tex. 2011).

Four years later, the Court in KCM Fin. LLC v. Bradshaw again examined the discretion an executive has concerning the right to lease. This time, the Court was faced with an executive’s affirmative action, leasing to a third party at a sub-market rate (the rental payments being received by the executive and NPRI holders in their respective proportions), in exchange for an above-market bonus payment (received only by the executive right holder). This led the Court to promulgate a standard which considered whether “the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.” KCM Financial LLC v. Bradshaw, 457 S.W.3d 70, 74 (Tex. 2015).

At that point in time, executive and NPRI holders alike did not have a clear idea of either (a) the level of duty owed to NPRI holders, or (b) what circumstances – affirmative or passive lease decisions – triggered this duty. In April 2019, the Court in Texas Outfitters Limited, LLC v. Nicholson had the opportunity to further distill these questions. Texas Outfitters Limited, LLC v. Nicholson, 572 S.W.3d 647 (Tex. 2019).

In 2002, Texas Outfitters Limited, LLC purchased surface rights to 100% of the subject land to operate its hunting business. Below the surface, three parties were involved; the Hindes family owned 50% of the mineral interest, including the executive right to that portion, Texas Outfitters owned the executive right to the remaining 50% of the minerals in question (but only received 4% of the mineral interest, while the Carters retained the remaining 46%). Several years later, El Paso Oil Exploration & Production Company struck a deal with the Hindeses to lease their 50%, while Texas Outfitters declined to lease on the same terms, against the express wishes of the Carters. Texas Outfitters reasoned any lease of the minerals would diminish the value of the surface estate, and therefore its hunting business. If the above fractions and percentages did not turn you away, you see where this is headed: Which standard will be used to determine another case concerning an executive’s “failure to lease”?

In reaching its decision, the Court applied what they deemed the “controlling inquiry” in all executive duty cases, the KCM standard, which up to this point only controlled affirmative lease decisions involving self-dealing. In doing so, they broadened this standard to encompass “refusal to lease” cases as well as cases involving actively leasing on favorable, self-dealing terms.

While we now have a clearer idea of the level of accountability an executive right holder has, a spotlight hovers over the executive right to lease mineral interests. Does this mean the value of an executive right may diminish? Will a potential executive be able to negotiate a lower price for this right now that it carries a broader, more stringent duty to NPRI holders? Will this lead to potential executives questioning whether such an obligation is worth buying? While the Court in Texas Outfitters did provide the clearest notion of an executive’s duty to date, this explicit standard leads to uncertain implications.

GOING TO JAIL WITHOUT PASSING GO – SECOND CIRCUIT HOLDS “PERSONAL BENEFIT” NOT REQUIRED TO MAINTAIN TITLE 18 SECURITIES FRAUD CLAIM

3 minute read

On December 30, 2019, the Second Circuit issued its United States v. Blaszczak1 opinion, eliminating a serious hurdle that might otherwise dissuade federal prosecutors from pursuing a Title 18 fraud claim against an alleged inside trader. The court determined that, unlike Title 15 securities fraud, federal wire fraud and Title 18 securities fraud claims do not require proof that the alleged insider received any personal benefit in exchange for the disclosure of non-public information.
In Blaszczak, federal prosecutors alleged that an employee of the Centers for Medicare & Medicaid Services (CMS) had been illegally disclosing information about reimbursement rate adjustments to a political consultant, who in turn, had been forwarding the information to a group of hedge fund managers, who were trading and profiting on the non-public information.
After the presentation of evidence, the district court instructed the jury that, in order to convict the defendants with Title 15 securities fraud, they would have to find the defendants received a “personal benefit” in exchange for the disclosure of non-public information. However, the court did not include the same “personal benefit” instruction in its Title 18 charge. After many days of deliberation, the jury acquitted each defendant on all counts alleging Title 15 securities fraud, but found the CMS employee guilty on one count of wire fraud, the political consultant guilty on two counts of wire fraud and two counts of Title 18 securities fraud, and the hedge fund managers guilty on one count of wire fraud and one count of Title 18 securities fraud.
On appeal to the Second Circuit, the appellants argued that pursuant to the Supreme Court’s Dirks v. SEC2 opinion, the district court erred by not including the “personal benefit” instruction in its Title 18 question. The Second Circuit rejected appellants’ argument, reasoning that Title 15 and Title 18 were enacted for very different purposes. Title 15 (the statute at issue in Dirks) was enacted as part of the Securities and Exchange Act of 1934. While Title 18 was enacted as part of the Sarbanes-Oxley Act of 2002. And, despite both statutes prohibiting schemes to “defraud,” the meaning of the operative term was not shared.
According to the court, Title 15 was enacted for the limited purpose of eliminating insider trading for “personal advantage.” Whereas, Title 18 “was intended to provide prosecutors with a different and broader—enforcement mechanism to address securities fraud than what had been previously provided in the Title 15 fraud provision;” it was purposed to overcome the “technical legal requirements” that other fraud provisions created.
The court determined that because the statutes were enacted for two very different purposes and because the personal benefit test in Dirks was “judge-made doctrine” specifically premised on the limited purpose of Title 15, the personal benefit test should not apply to Title 18 securities fraud claims. Still, the court rejected appellants’ argument that the district court had opened a “backdoor” through which prosecutors could effectively pursue securities fraud claims that would otherwise require proof of a personal benefit. The court rejected this argument, stating that there will always be statutory overlap—where prosecutors can choose between multiple statutory causes of action for the same underlying conduct—but that such overlap is no reason to ignore legislative intent. According to the court, if the legislature believed they had inadvertently created a “backdoor,” it was up to them to intentionally close it.
The takeaway is simple. Whether or not the alleged disclosing party has secured any benefit by sharing non-public information, it could face criminal liability for its actions. Defense attorneys should be cognizant of Title 18’s requirements when assessing the chances of acquittal and make their clients aware of such risk.

1 18-2811, 2019 WL 7289753 (2nd Cir. Dec. 30, 2019).↩
2 463 U.S. 646, 662 (1983).↩

Estate Planning Attorney Ashley McMillan Joins Carrington Coleman

less than a minute

(Last updated January 28, 2020)

Carrington Coleman welcomes estate and tax planning attorney Ashley McMillan as Of Counsel.

Her comprehensive practice involves providing estate plans including wills and trusts, as well as probate, estate administration, wealth management, asset protection and business succession plans tailored to the individual needs of clients.

“Ashley brings extensive experience in all areas of estate planning and administration,” said Carrington Coleman Managing Partner Bruce Collins. “Her expertise will both complement and continue to elevate the work of this group, to the benefit of our clients.”

To learn more about Ms. McMillan, visit her bio.

A former corporate counsel for non-profit associations and a trained mediator, her practice also involves corporate formation and transactions. She is a member of the Dallas Bar Association’s Estate Planning and Probate Section and served as the 2013-15 co-chair of the Dallas Association of Young Lawyers’ Elder Law Committee.

She earned her law degree in 2008 from Texas Tech University School of Law. While in law school she was a member of the Craven National Moot Court Team and a member of the Board of Barristers. A graduate of Ursuline Academy of Dallas, she earned bachelor of arts degrees in political science and psychology in 2005 from Wake Forest University.

Laura Hebert Promoted To Partner

less than a minute

(Last updated January 21, 2020)

Carrington Coleman is proud to announce our newly promoted partner, Laura Hebert. Laura’s practice focuses on corporate, M&A, private equity, and healthcare transactions. She also handles real estate and lending transactions. Laura has experience across a broad range of industries, including restaurants, hotels, and manufacturing. In her healthcare practice, she has also formed and overseen the certification of healthcare non-profit corporations, negotiated physician employment agreements, and formed management services organizations (MSOs).

She joined Carrington Coleman after obtaining her Juris Doctorate from the University of Texas School of Law. She also holds an M.A. and Ph.D. in Ancient Art and Archeology from New York University’s Institute of Fine Arts.

Carrington Coleman Building Upon Middle Market Expertise

2 minute read

(Last updated January 15, 2020)

Carrington Coleman has added three attorneys to its Dallas office, bolstering its corporate finance, tax, and public securities practices.

The addition of partners Bruce Hendrick and George Lee, and senior associate Andrea Perez will enhance the firm’s capability in handling corporate, mergers and acquisition and finance matters.

“These attorneys each have significant experience and expertise in transactional and regulatory matters here in Texas and nationally,” said Carrington Coleman’s Corporate & Finance practice group leader, Bret Madole. “Their addition is an exciting development in the continued expansion of our firm’s work on behalf of middle market clients.”

Mr. Hendrick’s practice focuses on business transactions within Texas. With a background as a certified public accountant and holder of an LL.M in taxation, he provides small companies, family businesses, startups, entrepreneurs, and social enterprises with a unique combination of legal, tax planning, finance, and accounting expertise, as well as deal negotiation and execution experience. Before launching his legal practice, Mr. Hendrick had a successful career on Wall Street, closing a number of deals for Fortune 100 companies while with Goldman Sachs, JPMorgan, and Citigroup.

Mr. Lee represents registered investment advisers, family offices, and private investment fund sponsors in matters intrinsic to the investment management industry, including fund formation, portfolio transactions, and securities compliance matters. He has been instrumental in helping shape state and federal rules including the SEC “Family Office Exception” under the Dodd-Frank Act and the Texas State Securities Board’s Exemptions from Registration rules for private fund management.

Ms. Perez works with public and private companies, private equity firms, and family businesses on a comprehensive range of complex corporate matters including mergers, entity formation, governance, intellectual property protection, and commercial contracts. Andrea also has a unique and thriving art law practice through which she assists galleries, museums, auction houses, collectors, artists, and art professionals with their unique art-related legal needs. She is also an adjunct professor of International Law and the Arts at Southern Methodist University’s Meadows School of the Arts.

DEBRÁN O’NEIL Named D Mag Best Lawyer Under 40

less than a minute

(Last updated March 13, 2020)

Congratulations to Debrán O’Neil! Debrán was named to D Magazine’s 2020 list of Best Lawyers Under 40 in Dallas. Debrán is a commercial litigator with a focus on the healthcare industry. She represents healthcare facilities and providers in commercial litigation and medical negligence cases and advises them on regulatory compliance issues. Debrán also represents other industry clients in commercial litigation, products liability, and personal injury defense matters.

D Magazine’s Best Lawyers Under 40 list honors Dallas’s up-and-coming attorneys. The list was compiled from nominations by area lawyers with a valid license to practice law in Texas and a final selection is made through an independent panel of distinguished attorneys working in conjunction with the magazine’s editors.

Loss of Privacy Rights When Purchasing Art

4 minute read

By:  Andrea N. Perez

In late 2018, the European Union adopted the Fifth Anti-Money Laundering Directive. This Directive updates previous guidance with a focus on regulating the art market and terrorism financing. By January 10, 2020, all EU nations (including the United Kingdom) were required to enact regulations to implement the Fifth Directive. But what do art and terrorism have to do with one another? Just as the Nazis did in World War II, today’s terrorist groups are stealing historical and cultural artifacts and selling them to fund their terrorist activities. In fact, art and antiquity sales are the second highest source of income for ISIS.1

In an effort to prevent sources of terrorist funding, all EU member states were required to enact regulations which increase the transparency of art purchase and sale transactions. The goal is to stop terrorism and locate looted artwork, but a necessary consequence of the Fifth Directive is that art dealers, collectors, and investors with no terrorist connections are more heavily regulated and scrutinized than ever before.

There are two main mechanisms that the Fifth Directive leans on to increase transparency in art transactions: (1) know your customer (“KYC”) disclosures, and (2) increased due diligence requirements. Both these mechanisms are common and noncontroversial in the purchase and sale of a home or business (banks always require KYC disclosures); but the art market is different. Secrecy is a long tradition in the art market, and what makes the industry so intriguing to wealthy collectors and investors. Although auctions at Christie’s and Sotheby’s are publicized, most art exchanges still take place in storage facilities called freeports. A freeport is a tax-free holding zone that offers numerous tax and confidentiality benefits that are especially attractive to high value art sales, and innumerable pieces of art and antiquities are stored and sold in these freeports each year. These freeports are located throughout the world, with the “premiere” freeport located in Geneva, Switzerland. It is estimated that over 1.2 million works of art are stored in the Geneva Freeport, effectively never becoming subject to the tax laws of any state or country.2

The KYC disclosures require “obliged entities” to reveal the identities of buyers and sellers in an art transaction occurring in the EU or the UK. An “obliged entity” is any individual or business trading or acting as an intermediary in the sale of artwork (including galleries and auction houses), and anyone storing, trading, or acting as an intermediary in the sale of artwork in freeports.3 If the value of the artwork or series of artworks being sold is €10,000 or more, the obliged entities must disclose personal information and conduct research confirming that the buyer and seller are who they actually say they are.4 This means that all those private collectors hiding their assets tax-free in freeports will have to disclose their identities when they engage in art transactions. Suspicious provenance or chain of ownership for an artwork, offshore companies or trusts, or a seller changing their story about how they came to own the work, are all red flags that have to be investigated before the art transaction can close.

Obliged entities must now: (1) identify all sellers and buyers and verify their identity, (2) identify all beneficial owners, and take reasonable measures so that they know who they are transacting with, (3) obtain information on the purpose and intended nature of the transaction, and (4) conduct systematic, ongoing monitoring of beneficial owners or existing customers and regularly update proof of registration of customers who are corporate or other legal entities.5 And if a customer is from a high-risk country (e.g., Syria, Yemen, Afghanistan, Iraq, and other nations under attack), the obliged entity must inquire about the source of the funds and the wealth of the customer. For those collectors and investors purchasing art in the EU and the UK, the Fifth Directive is a major deterrent for art transactions.6

The nations of the EU are not the only nations supporting these types of regulations of the art market. On May 18, 2018, the United States House of Representatives introduced the Illicit Art and Antiquities Trafficking Prevention Act (H.R. 5886), which sought to incorporate art transactions into the existing regulations under the Bank Secrecy Act. H.R. 5886 had similar requirements as the Fifth Directive. H.R. 5886 died in the Senate, but the House passed a second bill in March 2019 known as the Counter Act (H.R. 2514) in hopes of enacting these regulations again. To date, the Senate has not passed H.R. 2514.7

Most criticisms of the European Fifth Directive and the American Counter Act focus on burdens placed on small to mid-market dealers who do not have the resources to conduct the thorough due diligence these regulations demand.8 There is fear that smaller purchases will be less appealing because of the obligations of the parties involved in the transaction are not worth the investment. Furthermore, how will high-profile art fair transactions be handled? People travel from all over the world to purchase artwork at Art Basel, for example, an international art fair that only lasts for a few days. Given this type of time constraint, it is likely impossible for the obliged entities at art fairs such as this to comply with the Fifth Directive. There are also concerns that the illegitimate art transactions will simply take place outside of the EU and the UK to maintain secrecy, and the regulations with have no negative impact on terrorism funding but to force them deeper underground. It’s too soon to determine what effect the Fifth Directive regulations will have on the art market, but the fears continue to mount.

In summary, if you are an obliged entity and purchasing or selling artwork in the EU or UK, you will need to comply with the applicable nation’s version of the Fifth Directive. If you are a collector or investor and purchasing art working in the EU or UK, you will need to disclose much more information than before, and more than you are likely comfortable with. Additionally, failure to comply could result in heavy fines and up to two years in prison.

But even with these potentially difficult inconveniences, it is important to remember why they exist. The required disclosures may be intrusive, but the overall goal is to shut down a major source of income for terrorism and rogue countries, and bring the art industry out into the open.
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1. Plenderleith, Jake. “How the Art Market Helps Fund Terrorism.” International Compliance Association, 28 October 2019.
https://www.artatlaw.com/archives/new-anti-money-laundering-regulations-target-art-market.
2. Gompertz, Williams. “Geneva Free Port: The Greatest Art Collection
No-One Ca See.” BBC, 1 December 2016.
https://www.bbc.com/news/entertainment-arts-38167501.
3. Plenderleith, Jake. “How the Art Market Helps Fund Terrorism.”
International Compliance Association, 28
October 2019. https://www.artatlaw.com/archives/new-anti-money-laundering-regulations-target-art-market.
4. Id.
5. Id.
6. Id.
7. Brett, Jason. “Congress Passes Laws Against Threats Including
“Decentralized Cryptocurrencies.” Forbes. 5
November 2019. https://www.forbes.com/sites/jasonbrett/2019/11/05/congress-passes-new-bsa-laws-due-to- threats-including-decentralized-cryptocurrencies/#4dd72bcd6206.
8. Kelly, Ellsworth. “Recent EU Developments in Art Law and Cultural
Heritage.” Center for Art Law. 20 August 2019.
https://itsartlaw.org/2019/08/20/recent-eu-developments-in-art-law-and-cultural-heritage/.