Oil and Gas Investment Disputes in Texas

Working interests, royalties and units are securities

Texas Government Code section 4001.068 defines a security to include a certificate or instrument representing an interest in or under an oil, gas or mining lease, fee or title, as well as investment contracts and notes. The federal definition in 15 U.S.C. § 77b(a)(1) includes a fractional undivided interest in oil, gas or other mineral rights. So when a promoter sells fractional working interests in a well, units in a drilling program, or a share of royalties to investors who will not operate the property, the promoter is selling securities. The exception is the arrangement among industry participants who negotiate a joint operating agreement and share operations; that is a commercial relationship governed by contract, discussed below.

The Texas State Securities Board has treated oil and gas offerings as an enforcement priority for years. In its 2019 enforcement report, nine of the 33 administrative orders that year involved oil and gas offerings, and its orders routinely describe fractionalized working interests sold to the public without registration.

The common frauds

• Leases the promoter did not own. Investors bought interests in a prospect where the promoter held no lease, or held an expired one.
• Selling more than exists. More than 100 percent of the working interest sold across several "programs," so no investor owns what the papers say.
• Hidden dry-hole history. Offering materials that describe the prospect's geology but omit the operator's record of failed wells, prior lawsuits or regulator orders.
• Inflated costs and turnkey markups. A "turnkey" drilling price far above actual cost, with the difference kept by the promoter and never disclosed.
• Commingling and reallocation. Money raised for one well used to drill another, pay earlier investors or fund the promoter's overhead.
• Fictitious production. "Distributions" that were new investor money, not oil revenue, which is a Ponzi structure.

The Texas Securities Act claims

Three provisions carry most oil and gas investor cases.

Untrue statement, section 4008.052. A seller is liable to the buyer for a sale by means of an untrue statement of a material fact or a misleading omission. No intent is required; the seller defends only by proving the buyer knew the truth or that the seller could not have known it with reasonable care. A false statement about lease ownership, the interest sold, the operator's history or the drilling cost fits squarely.

Unregistered sale, section 4008.051. A sale of a security without a permit, registration or valid exemption, or by a dealer or agent who was not registered, gives the buyer a rescission claim without any misstatement. Oil and gas programs are often sold by telephone salesmen paid commissions who are not registered with the State Securities Board, and the programs themselves often claim a Rule 506 exemption while advertising publicly, which forfeits it. That makes the registration claim the first one to check.

Control persons and aiders, section 4008.055. The promoter's principals are jointly liable as control persons unless they prove they could not have known the facts, and the salesmen, marketing firms and sometimes the operator are liable as aiders if they materially aided the sale with intent to deceive or reckless disregard. The structure is explained in the control-person and aider guide.

The remedy under section 4008.056 is rescission: tender the interest and recover what you paid with interest at the legal rate, less any income received. Federal Rule 10b-5 adds a fraud claim in federal court where intent can be shown. Common-law fraud and the Texas Theft Liability Act are pleaded alongside when the money was simply taken.

Example

Suppose a Southlake investor buys a 2 percent working interest in each of three wells in a West Texas prospect for $180,000, after a salesman describes the operator's "twelve producing wells on adjacent acreage" and a turnkey cost that "covers everything to the tanks." Railroad Commission records later show that the operator has drilled four wells in the county, two of them plugged, and that the leases for two of the three prospects were assigned to the promoter's company only after the investor paid. The salesman was never registered in Texas and was paid 15 percent of each sale. The investor has a section 4008.052 claim for the misdescribed record and the lease status, a section 4008.051 rescission claim because of the unregistered salesman, and section 4008.055 claims against the promoter's owner as a control person and against the salesman as an aider if he knew the pitch was false. He recovers the $180,000 with legal interest, less any production checks received, without proving the promoter intended to deceive.

Joint operating agreement disputes are different

Working-interest owners who hold their interests under a joint operating agreement with an operator have a contract relationship, not an investor-promoter one. Their disputes are about joint interest billings, overhead charges, non-consent penalties for declined operations, the operator's accounting, lien rights for unpaid bills, and whether the operator met the agreement's standard of conduct. Those are breach-of-contract and accounting claims, with remedies defined by the agreement's audit and dispute provisions. An operator who inflates billings or fails to pay revenue may also face fraud or conversion claims, but the Texas Securities Act generally does not apply to the ongoing relationship among owners who were not sold their interests as investments. The line can blur when the "operator" also sold the interests to passive investors, in which case both sets of claims may exist. Contract remedies are covered in the breach of contract guide.

Records that prove or disprove the deal

• Railroad Commission of Texas records. Public well, permit, completion and operator data show whether the wells exist, who operates them and what they produce.
• County deed records. Leases and assignments are recorded; they show who owned the lease and when.
• Division orders and revenue statements. They show the interest you were actually credited with, which can be compared with what you were sold.
• The offering materials, subscription agreement and every email or recorded call from the salesman.
• The promoter's Form D on the SEC's EDGAR system and the State Securities Board's registration and enforcement records, which show whether the program claimed an exemption and whether the people involved have prior orders.

Deadlines and forum

Under section 4008.062 the registration claim must be filed within three years after the sale, and the misstatement claim within three years of discovery and no more than five years after the sale. Fraud and theft claims carry four years under Civil Practice and Remedies Code section 16.004. Federal fraud claims run two years from discovery and five from the violation. Cases are filed in Texas district court, often in Dallas County when the promoter sold from here, or in federal court when a Rule 10b-5 claim is included; subscription agreements sometimes contain arbitration or venue clauses that must be checked first. Where the promoter is insolvent or a receiver has been appointed, the guide on recovering losses from a Ponzi scheme describes how the claims process and clawbacks work.

When to involve a litigator

As soon as the public records disagree with the pitch, or distributions stop with explanations that do not match production data. The registration claim runs from the sale, not from discovery, so it has the shortest fuse, and the salesman's records and the promoter's bank accounts are easier to reach before the next program is sold. Tina Wysk represents investors and energy companies in oil and gas investment disputes in Dallas state and federal courts; see securities and investment disputes.