Royalty Payments To Landowners In Changing Times

Mining leases in Texas may take many different forms. Although most cover the basic legal requirements of a lease, it is probably fair to say that over the years relatively few mining leases have dealt with the relationship between the landowner and the mine operator in a manner which successfully balances the long term nature of such leases and the changing world in which we live. It is beyond the scope of this article to attempt to address balance in every aspect of mining leases but several areas are particularly important, regardless of the material being mined. One of those important areas is the amount that is to be paid the landowner.

Virtually every mining lease contains provisions that require the landowner be paid an amount for the material that is extracted and sold from their land. For many types of materials, that amount, which historically has been termed a “royalty”, is expressed as (i) a fixed sum for each ton sold, adjusted from time to time to reflect inflation, or (ii) a sum for each ton sold that is equal to a stated percentage of an amount which represents the average sales price received by the mine operator for the material. They are both generally considered to be fair ways to share the revenue received for the material, as neither in practice seems to favor one party over the other.

Regardless of the method chosen, the quantity of material sold must be known. Traditional leases often required that quantities be established by weighing delivery trucks. Although the results may be reliable, the requirement that each truck be weighed may become inappropriate over time as mining and marketing practices change. As with any business, flexibility is important. Leases should allow mine operators to be flexible while ensuring that the measurement of sales is accurate. One means of achieving that goal is to permit operators to measure quantities using methods which are then considered customary and reliable; for example, the method they use to charge their customers.

Apart from determining quantities, the calculation of royalties based upon a fixed sum for each ton sold is straight forward. The royalty rate is usually adjusted by an inflationary index, but otherwise involves the simple multiplication of the applicable rate by the number of tons sold. The calculation of royalties based on a percentage of the presumed average sales price is somewhat more complex. Because it is generally not practical for larger operators to calculate royalties and make payments each month on the basis of current sales, parties typically agree to approximate the average price, based on sales that were made during a preceding period of time, and then multiply that price by the applicable percentage.

In doing so, the parties must consider the amounts that are to be included in the “sales price” and the way those amounts are to be treated in arriving at an “average”. They must also take into consideration another important element; the places where the delivery of the material may occur. If the sales price is always based on delivery at the mine, it will not include the cost of transportation to another destination. If, however, deliveries may occur at distant locations, transportation and other costs may be included in the price and they will significantly increase the amount of the royalty due, even though such costs may not relate to the value that has been provided by either party.

In a sense, mining on leased property involves a combined enterprise between the landowner, who owns reserves of materials, and a mine operator, who has the resources to extract and distribute them. As mentioned above, royalties are a way to share the benefits received from that enterprise. To do so successfully requires that careful thought be given to the details of how the royalties should be calculated so the resulting amount is as the parties intend, both at the time the lease is made, as well as in the future when circumstances may, and almost certainly will have changed.