Texas Supreme Court Decision in Coastal v. Garza: Rule of Capture Bars Recovery of Drainage Damages for Subsurface Trespass from Hydraulic Fracturing
Submitted by Daniel M. McClure, William D. Wood and Robert S. Ballentine, Fulbright & Jaworski LLP

On August 29, 2008, the long-awaited decision in Coastal Oil & Gas Corp. v. Garza Energy Trust ¹ and its anticipated disposition of whether hydraulic fracturing that extends beyond lease lines constitutes common law trespass was delivered by the Texas Supreme Court. According to the opinion, written by Justice Nathan L. Hecht, damages based upon the drainage of natural gas from underneath the plaintiffs’ property caused by fractures extending across lease lines generated by hydraulic fracturing of a natural gas well on adjacent land, fail to support a claim for subsurface trespass because the rule of capture effectively bars the recovery of any such damages. The opinion, however, expressly declined to decide whether subsurface fracing could ever give rise to an action for trespass.

The significance of this recent Supreme Court decision is that it reverses a 2005 Corpus Christi Court of Appeals decision that had affirmed a $14 million trial court judgment against Coastal Oil & Gas Corp. in which it was held that Gregg v. Delhi-Taylor Oil Corp. ² remained the law in Texas with respect to subsurface trespass by hydraulic fracture stimulation and that the royalty owners “owned a real property interest against which Coastal trespassed.” Mission Resources, Inc. v. Garza Energy Trust, 166 S.W.3d 301 (Tex. App. – Corpus Christi 2005), pet. granted sub nom., Coastal Oil & Gas Corp. v. Garza Energy Trust, 2006 Tex. LEXIS 1342 (Tex. Apr. 21, 2006). ³ In the wake of the Corpus Christi Court’s decision, there was a palpable concern among many participants in the oil and gas industry that lawsuits against well operators and well service companies calculated to impose liability against them for subsurface trespass would proliferate. While last week’s Supreme Court decision failed to eliminate all claims of subsurface trespass that may be associated with hydraulic fracturing, it will no doubt ease concerns by eliminating drainage-based damages claims for hydraulic fracing.

The Supreme Court's Principal Decision

The plaintiffs consisted of a large number of mineral owners, referred to collectively in Justice Hecht’s opinion as “Salinas.” In the trial court, Salinas alleged that Coastal committed a subsurface trespass by conducting hydraulic fracturing operations on its Coastal No. 1 well, whose surface location was situated on Coastal’s fee property adjacent to the Salinas property under lease to Coastal. Salinas alleged that Coastal’s fracing operation caused natural gas and gas condensate to drain across Salinas’s property lines to the Coastal No. 1 where Coastal produced Salinas’s gas and condensate without having to pay Salinas royalties on it. The drainage of royalty-generating gas and condensate constituted Salinas’s only alleged measure of economic damages. Salinas further claimed that Coastal pooled Salinas’s leases in bad faith and that Coastal breached its implied covenants to protect Salinas’s properties against drainage and to reasonably develop Salinas’s leases.

Coastal argued unsuccessfully to the Texas Supreme Court that, because Salinas owned mere royalty interests and the possibility of reverter, Salinas had no possessory right to the minerals and, consequently, lacked standing to claim trespass. A mineral lessor with only a reversionary interest thus has standing to bring a claim for a subsurface trespass that caused actual injury to the lessor. What Salinas lacked in this case, however, was evidence of any actual injury. Salinas's loss of natural gas and condensate drained from their properties as a result of Coastal's hydraulic fracturing operations on adjacent land is subject to the rule of capture, which bars their claim for subsurface trespass. The Supreme Court also held:

• The measure of damages for breach of the implied covenant to protect against drainage is measured by the value of the minerals lost because of the lessee's failure to act with reasonable prudence (of which there was no evidence in this case, according to the Supreme Court); and
  
  
• There was some evidence in this case supporting the jury's finding of breach of Coastal’s implied covenant to develop and Coastal’s bad-faith pooling of Salinas’s properties with those of others.

The Supreme Court reversed and remanded the case to the trial court in Hidalgo County, Texas for further proceedings.

Rule of Capture Negates Actual Damages Based on Drainage

Justice Hecht articulated four fundamental reasons not to change the rule of capture in a way that would permit one property owner to sue another for alleged drainage caused by hydraulic fracturing that extends across lease boundaries:

• The drained mineral owner, irrespective of whether fracing caused the drainage, has at his disposal complete recourse through (i) exercising self-help by drilling his own protection well if he does not already have a well on his property, (ii) suing his lessee for violating the implied covenant to protect his lease against drainage, (iii) voluntarily pooling his lease or force pooling by applying to the Railroad Commission of Texas, or (iv) seeking Railroad Commission of Texas regulation of production to prevent drainage.
  
  
• The Railroad Commission, not Texas courts, should continue to regulate oil and gas production. Ownership of the minerals in place does not extend to specific minerals and ownership must be considered in conjunction with the law of capture. “Without the rule of capture, drainage would amount to a taking of a mineral owner’s property – the oil and gas below the surface of the property – thereby limiting the Commission’s power to regulate production to assure a fair recovery by each owner.” According to Justice Hecht, the rule of capture leaves unimpeded the Commission’s historical role of “regulating the production of oil and gas for the prevention of waste as well as for the protection of correlative rights. The [Railroad] Commission’s role should not be supplanted by the law of trespass.”
  
  
• The Texas Supreme Court “should not alter the rule of capture on which an industry and its regulation have relied for decades to create new and uncertain possibilities for liability with no more evidence of necessity and appropriateness than this case presents.” In this case, the experts for Salinas and Coastal agreed that (a) hydraulic fracturing is essential to the recovery of oil and gas in many areas – including, in this instance, the relatively imporous and impermeable Vicksburg T “tight” sandstone formation located at depths of 11,688’ to 12,610’ subsurface – and (b) some amount of drainage is virtually unavoidable. “In this context, common law liability for a long-used practice essential to an industry is ill-advised and should not be extended absent a compelling need that the [Texas] Legislature and [Railroad] Commission have ignored. No such need exists.”
  
  
• Finally, many regulators, landowners, royalty owners, operators and hydraulic fracturing service providers submitted amicus briefs opposing any imposition of liability for hydraulic fracturing. Some of the submissions included statements urging that the Corpus Christi court of appeals decision, if left standing, would (i) be disastrous for royalty owners since operators facing potential tort liability for their hydraulic fracturing operations would curtail such operations and significantly reduce payments to royalty owners such as Salinas, (ii) lead to chaos for producers and well service companies, (iii) impose massive costs on the industry and impede mineral reserves development, (iv) dissuade operators from continued use of hydraulic fracturing techniques, and (v) adversely affect the Railroad Commission’s ability to prevent waste. Hydraulic fracturing is one of the few industry practices in which neither the Texas Legislature nor the Railroad Commission of Texas have seen fit to regulate during the sixty years of its utilization; there is simply no need to superimpose common law liability over such a well-established activity, according to Justice Hecht.

The Rest of the Decision

The landowners also alleged breach of the implied covenant to protect the property against drainage, breach of the implied covenant to develop, and bad-faith pooling. The Supreme Court refined its definition of the measure of damages for breach of the implied covenant to protect against drainage by holding that “the correct measure of damages is the amount that will fully compensate, but not overcompensate, the lessor for the breach – that is, the value of the royalty lost to the lessor because of the lessee’s failure to act as a reasonably prudent operator.” Absent any evidence of the proper measure of damages, including evidence of the amount of drainage that a reasonably prudent operator such as Coastal should have prevented, the lessor cannot recover on his claim for breach of the protection covenant.

Coastal’s delay in drilling additional wells breached its implied covenant to develop, according to the jury. “For breach of the development covenant, a lessee [sic] is entitled to recover ‘the full value of royalty lost to him’.” However, due to a finding that the trial court abused its discretion in admitting into evidence a certain unfairly prejudicial memorandum, Coastal is entitled to a new trial on Salinas’s alleged breach of the implied covenant to reasonably develop. For the same reason, despite the jury’s verdict that Coastal had pooled Salinas’s property in bad faith, Coastal is entitled to a new trial on this claim as well.

The jury had found that Coastal acted with malice, defined by the trial court as specific intent to cause substantial injury or conscious indifference to the rights of others. The jury had also found “beyond a reasonable doubt” that Coastal was guilty of felony theft of the minerals drained from under the Salinas’s property, thereby effectively eliminating the statutory cap on punitive damages, which were awarded to Salinas in the amount of $10 million.

The Supreme Court rendered judgment that Salinas take nothing on the claims for trespass and breach of the implied covenant to protect against drainage. The balance of the case – Coastal’s alleged breach of the development covenant and alleged bad-faith pooling – is remanded to the trial court for a new trial.

Conclusion

Whether subsurface fracing can give rise to an action for trespass remains essentially undecided ("[w]e need not decide the broader issue here") after Coastal v. Garza’s more narrow holding in which Justice Hecht wrote:

[W]e hold that damages for drainage by hydraulic fracturing are precluded by the rule of capture.

Moreover, although not called upon to address any such circumstances in Coastal v. Garza, Justice Hecht suggests that other potential claims may retain their viability under certain limited conditions:

It should go without saying that the rule of capture cannot be used to shield misconduct that is illegal, malicious, reckless, or intended to harm another without commercial justification, should such a case ever arise.

Similarly, in his concurring opinion, Justice Don R. Willett observes that “the Court implicitly leaves trespass as a potentially viable theory in suits seeking ‘nondrainage’ damages, for example, when a reservoir or nearby drilling equipment is damaged” by hydraulic fracturing operations. He maintains that a claim for negligence, not trespass, would be appropriate under such circumstances. Moreover, he reasons, trespass by hydraulic fracturing should not be recognized as a cause of action in either drainage or nondrainage situations.

In his opinion concurring in part and dissenting in part, Justice Phil Johnson (with whom Chief Justice Jefferson and Justice Medina joined) writes that Coastal’s primary issue raised in this case – whether hydraulic fracturing across lease lines constitutes subsurface trespass – must be addressed by the Court. Arguing that the majority opinion written by Justice Hecht changes the rule of capture, he writes that “I would not hold that the rule of capture applies to gas produced . . . by means of the hydraulic fracture [and] I would not render judgment for Coastal on the trespass claim based on the rule of capture.”

¹ Coastal Oil & Gas Corp. v. Garza Energy Trust, Slip Opin., No. 05-0466 (Tex. Aug. 29, 2008). Copies of the Court’s opinion,
as well as an opinion dissenting in part and concurring in part and a concurring opinion are accessible at
http://www.supreme.courts.state.tx.us/historical/082908.asp.
² In 1961, the Texas Supreme Court held in Gregg v. Delhi-Taylor Oil Corp. that fracing can create a subsurface trespass if
“the invasion alleged is direct and the action taken is intentional.” Gregg v. Delhi-Taylor Oil Corp., 344 S.W.2d 411, 416 (Tex. 1961).
In 1992, the Court used less equivocal language to once again raise the specter of trespass liability for hydraulic fracturing operations
in Texas when it plainly wrote: “[f]racing under the surface of another's land constitutes a subsurface trespass.” Geo Viking, Inc. v.
Tex-Lee Operating Co., 1992 Tex. LEXIS 40; 35 Tex. Sup. J. 661 at *5 (Apr. 22, 1992) (citing Gregg v. Delhi-Taylor Oil Corp.,
344 S.W.2d 411, 416 (Tex. 1961) and Amarillo Oil v. Energy-Agri Products, 794 S.W.2d 20, 27 (Tex. 1990)), writ denied per curium,
Geo Viking, Inc. v. Tex-Lee Operating Co., 839 S.W.2d 797 (Tex. 1992). Six months later, the Court withdrew its Geo Viking opinion,
thereby removing its precedential value. Geo Viking, Inc. v. Tex-Lee Operating Co., 839 S.W.2d 797, 798 (Tex. 1992) (withdrawing its
prior opinion and cautioning that “we should not be understood as approving or disapproving the opinions of the court of appeals
analyzing the rule of capture or trespass as they apply to hydraulic fracturing”).
³The Corpus Christi court of appeals' May 5, 2005 decision had affirmed the trial court's 2001 damage awards of $543,776 for the
drainage of natural gas from under the royalty owners’ properties, $81,619 for Coastal’s bad faith pooling of their properties, and $10
million in punitive damages based on jury findings of malice and felony theft.