Sometimes the well-worn phrase “be careful what you ask for” is actually true. In City of Dallas v. Trinity East Energy, LLC (No. 05-20-00550-CV), the City found out the hard way and will have to shell out nearly $34 million into the bargain.
The case arose from the City’s denial of special use permits allowing Trinity East Energy, an oil and gas producer in the Barnett Shale, to drill sites included in a lease with the City. In response to a 2007 request for proposals, Trinity proposed to augment its existing drill sites in close proximity to the tracts the City offered for lease. Trinity won the bid and while negotiating a lease with the City performed seismic work and due diligence. In May 2008 Trinity drilled a science well on land owned by the University of Dallas, which concluded that the leased tracts could be commercially produced. Trinity and the City executed the lease in August 2008. Trinity paid a lease bonus of more than $19 million, a 25% royalty on gas, and an overriding royalty interest on gas produced from other leases through wells on City drill sites. The lease covered 2,000 acres and identified one tract as a drill site location, as well as three other tracts as proposed drill site locations. Simultaneously with executing the lease, Trinity received a letter of assurance from the City Manager that the City staff would use best efforts to assist Trinity in obtaining the special use permits necessary to conduct drilling operations. Trinity thus commenced preparations for drilling, which included engineering, surveying, drill site pad design, pipeline alignment, archaeological and tree surveying, and seeking the appropriate federal, state, and local regulatory approvals.
But in 2010, when Trinity submitted its completed permit applications, things fell apart. At this time the City conducted a review of its gas drilling ordinance, which delayed the permit applications. In December 2012 the City Planning Commission denied the applications. Though the City Council could override the Planning Commission with a three-fourths majority, only a majority of councilmembers voted for it, killing the deal. Finally, in December 2013 the City amended its gas drilling ordinance to impose strict setback and other restrictions that rendered drilling on the leased land impracticable. So the leases expired.
Trinity responded to this expensive debacle by suing the City on multiple causes of action, including inverse condemnation. In a jury trial, Trinity presented evidence that the City’s actions deprived it of the fair market value of the tracts under lease. It also presented evidence that the value of the property after denial of the special use permits was zero. The jury found that the City committed statutory fraud and negligent misrepresentation and awarded damages based on the fair market value of the property before and after denial of the permits. The trial court found that the City had committed a regulatory taking by denying the permits and awarded compensation of $33,639,000. The City appealed.
The court of appeals affirmed. In order to make a showing of inverse condemnation, Trinity had to produce sufficient evidence to demonstrate “an intentional government act that resulted in the uncompensated taking of his property” (citations omitted). A taking may be accomplished by either “physical or regulatory means,” and a “regulatory taking is a condition of use ‘so onerous that its effect is tantamount to a direct appropriation or ouster” (citations omitted). Trinity’s allegations could constitute either a Lucas claim or Penn Central claim. Under Lucas v. S. Cent. Coastal Council, 505 U.S. 1003, 1015-19 (1992), the “property owner alleges that a property regulation denied the owner of all economically beneficial or productive use of the property. For a claim under Penn Cent. Transp. Co. v. N.Y.C., 438 U.S. 104, 124 (1978), the property owner must show that “while a regulation did not deprive the owner of all economically viable use, the governmental action unreasonably interfered with the owner’s use and enjoyment of the property.” The court’s analysis proceeded under a Lucas theory.
The court of appeals found that Trinity produced sufficient evidence to permit a reasonable factfinder to conclude that the City had committed a regulatory taking. The key facts included: (1) absent the City leases, Trinity did not have reasonable access to other surface locations from which it could have productively produced gas; (2) the denial of the special use permits left Trinity without alternative drill sites that were “viable or feasible for economically developing Trinity’s mineral property”; (3) Trinity could not have drilled wells from sites in Irving and Farmers Branch, in which it already had special use permits, because such wells would require excessively long well bores; (4) there were no other alternative sites, from the City or otherwise, which could have compensated Trinity for the loss of the leased property; and (6) Trinity was well on its way to obtaining all other regulatory approvals, so a reasonable factfinder could conclude that the City’s denial of the permits cost Trinity its part of the bargain in the lease. The court this ruled that the evidence was legally and factually sufficient to support the trial court’s judgment.
The City next challenged Trinity’s expert, a petroleum engineer specializing in reservoir engineering. It argued that the expert’s opinion of the value of the leased property was not reliable because it was based on sales of incomparable properties and an unreasonably high estimate of the future value of gas (from which the expert applied a 10% discount to present value). The court brushed this argument aside, finding that the trial court did not abuse its discretion in admitting the testimony as to the comparable sales the expert used in his analysis. It likewise rejected the City’s contention that the discounted cash flow the expert assumed from future production was unreasonably uncertain. Noting that evaluating the fair market value of an income-producing property by discounting a future income stream is common, the court found that the expert’s estimate of future prices was derived from public sources generally available in the industry. The expert’s use of historical data from existing wells, to which he developed an average curve based on both good and bad well, was likewise reasonable. Whether the leased interests would have produced in commercially productive amounts was indeed uncertain, but that is the factfinder’s decision based on the evidence. Quoting Phillips v. Carlton Energy Group, LLC, 475 S.W.3d 265, 280 (Tex. 2015), the court observed that “[W]hen evidence of potential profits is used to prove the market value of an income-producing property asset, the law should not require greater certainty in projecting those profits than the market itself would.” The court thus upheld the judgment.
It is difficult for us to see what the City’s strategy was, if there even was a strategy. It requested proposals to develop minerals on City property, executed a lease with an experienced operator that produced existing leases in the area, received $19 million in up-front cash, and a generous royalty deal. So the City got what it asked for, only then to carry out a slow-motion reversal that ended with Trinity out-of-pocket and out-of-luck. Perhaps the City thought the courts in Dallas County wouldn’t apply the law to the facts, but that’s exactly what they did.
