Royalty owners in Texas are taxed annually based on the value of their mineral interests. Frequently, their interests are joined with other royalty owners’ interests in a practice called pooling. Pooling provisions in oil and gas leases are useful tools. Pooling clauses, in conjunction with unitization agreements, allow lessees to combine acreage covered by two or more leases to create a single production unit over a common reservoir (often called a “unitized tract”). This helps prevent waste, preserve minerals, and protect the rights of landowners over a common reservoir. However, pooling provisions can expose a lessor to taxes from multiple counties.
For example, when a landowner leases mineral rights below the surface tract of a property located in a single county, and those rights are pooled and unitized with other mineral interests in that county, the lessor pays tax on a pro rata basis to the single county. However, when the mineral rights are derived from a pooled unit situated in two counties, the lessor’s royalty payments are almost always subject to property taxes in both counties. Thus, the lessor is taxed on his or her royalty payments by a county in which the lessor owns no land. The neighboring county assesses the lessor for property taxes based on the doctrine of cross-conveyancing – the idea that all parties subject to a pooling agreement own an undivided interest in the pooled unit. Production anywhere on a pooled unit is treated as production on every tract in the unit. However, oil and gas leases often expressly prohibit cross-conveyances of mineral interests. This tension between contractual mineral rights and property taxes was recently addressed by the Texas Twelfth Court of Appeals in Tyler.
Landowners in Shelby County (the “Lessors”) entered into oil and gas leases with pooling provisions. The Lessors’ subsurface mineral interests were unitized with mineral interests in Shelby County and San Augustine County, Texas.
The leases also prohibited the cross-conveyance of the Lessors’ mineral interests, meaning the leases did not transfer title of the Lessors’ mineral interests to other mineral owners in the pooled unit. Notwithstanding, the Lessors signed division orders and accepted royalty payments from the entire pooled unit which included mineral interests owned by landowners in San Augustine County.
The Lessors paid taxes only to Shelby County – where their surface estate was located – and accepted the valuation appraisal for the minerals from the Shelby County Appraisal District. The Lessors disputed the valuation appraisal and tax assessment from the San Augustine County Appraisal District, refusing to pay taxes on minerals located under land that was not owned by them.
Even though the leases specifically prohibited cross-conveyancing of mineral interests, the San Augustine County Appraisal District argued that, by signing division orders the Lessors acknowledged ownership within the entire pooled unit. The district also claimed that by accepting royalty payments pursuant to the division orders, the Lessors could not utilize the prohibition against cross-conveyancing as a basis for not paying taxes in San Augustine County.
Put simply, San Augustine County Appraisal District argued that notwithstanding the specific lease prohibition barring cross-conveyancing, the taxpayer had in reality cross-conveyed its interests by accepting royalty payments from the pooled unit.
“No Texas statute provides for taxation of minerals outside the boundaries of the taxing unit merely by virtue of the fact that they are included in a production unit pursuant to a pooling agreement.”
The appellate court ruled that the signing of division orders and acceptance of royalty payments from a pooled unit does not override a written mineral lease.
Prospective Effect on Texas Ad Valorem Tax Scheme
The San Augustine County Appraisal District argued its method of assessing the mineral interests strictly follows the method used by appraisal districts throughout Texas. The district claimed that depriving appraisal districts of the ability to rely on division orders and unitization agreements would result in “uncertainty in every royalty payment,” forcing taxing districts to review every lease, many of which are not of public record. In response, the appellate court stated, “SCAD [the appraisal district] is required to apply the law, even if it means adapting as the applicable law is clarified through the judicial process.”
Now that this area of law has been “clarified,” royalty owners need to see if their leases are pooled with leases in other counties, determine whether their leases prohibit cross-conveyancing, and protest the illegal taxation to their appraisal review boards. The deadline for doing so this year is May 17, 2021. It is possible that some royalty owners may be entitled to retroactive five-year tax refunds.
 Division orders are legal instruments that document a royalty owner’s intertest in the production of a certain well.
 San Augustine County Appraisal Dist. v. Chambers, 12-20-00128-CV, 2021 WL 219300, at *4 (Tex. App.—Tyler Jan. 21, 2021, pet. filed)