A Houston appeals court recently issued an opinion affirming the right of cities to reasonably regulate oil and gas drilling.   In City of Houston v. Trail Enterprises, an energy company sued the city for restrictions the city placed on drilling in the city, claiming that the restrictions worked a “regulatory taking” of the company’s property.

The case is interesting because it clearly applies the relevant legal test to a city’s oil and gas well regulations.   Takings law is somewhat complex, but it can be broken down into two basic actions that are prohibited, absent compensation, by both the U.S. and Texas Constitutions:  (1) a physical invasion of property (e.g., using someone’s property for a road or to install utility infrastructure); or (2) a regulation that deprives the owner of the use of his property.

The second type of taking, known as a regulatory taking, is determined based on tests created by the courts.  A regulation can be a taking if it: (1) does not advance a legitimate government interest; or (2) denies the owner all economically beneficial use of his land.  Assuming a regulation advances a legitimate government interest (e.g., protecting citizens and the environment from pollution) and does not deny an owner of all economically beneficial use of his land (e.g., an owner can still use his land in many ways other than drilling for oil or gas), a city’s ordinance may be upheld.  However, the courts can also apply a “justice and fairness” test to the regulation.

Using both U.S. and Texas Supreme Court precedent, the opinion explains that there is no bright-line test as to whether a regulation works a taking.  Rather, the “inquiry involves a determination of whether ‘justice and fairness’ require economic injuries caused by government action to be compensated by the government actor.”

Three factors relate to striking that balance: (1) the character of the governmental action; (2) the extent to which the regulation has interfered with reasonable and distinct investment-backed expectations; and (3) the economic impact of the regulation on the claimant.

In the Trail case, the court concluded that, because the company did not buy the land in reliance on drilling new wells and because the company still had older wells on the property that were producing, the city’s regulation was not a regulatory taking of the property.  It also affirmed that protection of a city’s drinking water source is clearly a legitimate governmental interest.  Because the disputed claim is around $19 million, the case will likely be appealed to the Texas Supreme Court.

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