Recently in Negotiating Leases Category

July 16, 2013

Thoughts on the Oil and Gas Lease

Last week I presented a paper at the Texas State Bar Advanced Real Estate CLE Conference for attorneys in San Antonio. I was asked to write a paper giving real estate attorneys a basic introduction to negotiating oil and gas leases. It might seem odd that real estate attorneys would want a primer on oil and gas leases; most people would assume that an attorney practicing real estate law in Texas would know about oil and gas leasing. And that used to be true, when the majority of attorneys had a rural general practice. General practitioners in Texas knew the basics of real estate and oil and gas law and often helped their landowner clients negotiate leases. Today, most real estate attorneys have little to do with oil and gas matters, and as practices have become more specialized the oil and gas specialty has diverged from the real estate specialty.

I was given thirty minutes to make my presentation - hardly enough time to do justice to the subject of oil and gas leases. The exercise of preparing my remarks caused me to focus on some basic concepts that I've not recently thought about, and I decided they would make a good topic for discussion here.

The oil and gas lease is in many ways a unique form of contract. It is the foundation of the oil and gas industry in the U.S. Because most minerals in the U.S. -- unlike most of the world -- are privately owned, some way had to be found for those willing to risk capital to exploit oil and gas to obtain rights to those resources. The oil and gas lease was the result. In its basic form, the oil and gas lease has remained unchanged since the early days of the industry.

The concept is simple: the mineral owner conveys the mineral estate in her land to the company that wants to exploit the minerals, for a term -- a "primary term" of years, and a "secondary term," for as long thereafter as oil or gas is produced. In that conveyance, the mineral owner reserves a cost-free interest in production - a royalty interest. The landowner thus transfers the risk and cost of development to the grantee, and retains a risk-free royalty interest in production.

The oil and gas lease is both a conveyance and a contract, and the law that has developed around the lease reflects both concepts. Its character as a conveyance has important consequences, and it is important for the landowner to understand those consequences, especially if the landowner owns both the surface and mineral estates. The mineral estate is the "dominant" estate, meaning that the owner of the mineral estate has the right, without compensation, to use so much of the surface estate as is reasonably necessary to explore for and produce oil and gas from the property. This basic idea is subsumed within the lease. The grantee in the lease acquires not only the mineral estate but also the right to use the surface estate for mineral development. This includes the right to build roads, lay pipelines, install production facilities, conduct seismic surveys, etc. And it includes the right to use groundwater for oil and gas exploration and production and the right to dispose of produced water and associated waste by drilling and operating injection wells on the property. All of these rights are implied in the grant of the mineral estate, and need not be specifically mentioned in the lease. If the landowner wants to restrict the lessee's right of surface use in any way, those restrictions must be provided for in the lease. Absent such express contractual restrictions, the right of surface use is part of the bundle of rights granted to the lessee as part of the mineral estate.

An oil and gas lease is also a contract and enforceable as such. As the case law interpreting oil and gas leases began to develop, courts began to imply certain provisions into the lease, as a matter of contract interpretation. Courts considered that the lease imposed certain obligations on the lessee that were not expressed in the contract but were necessary in order for the parties to have the benefit of their bargain. These implied obligations are now well-recognized, and include the obligation to reasonably develop the lease and the obligation to protect the lease against drainage by wells on adjacent lands. Courts also created rules for construction of certain lease provisions. For example, leases remain in effect for a term of years and "as long thereafter as oil or gas is produced." But what if there is a temporary cessation of production? Does the lease terminate? Faced with this question, courts developed the rule of "temporary cessation." A lease will not terminate because of temporary lapses in production if the lessee acts diligently to restore production.

A body of law also developed around the construction of the royalty reservation in oil and gas leases. The royalty reserved in a lease is both an interest in the land - a real property interest that can be conveyed, devised, or gifted - and a contractual obligation of the lessee to make payments to the lessor. What does it mean that the royalty is "cost-free"? In Texas, courts have generally concluded that royalties are free of the costs of exploration and production but must bear their share of "post-production costs." Again, this interpretation applies unless the parties provide otherwise in the lease agreement. How and when the royalty is calculated and paid is a source of much contention in the courts, largely because of the parties' failure to adequately address the issue in the lease itself.

The law surrounding oil and gas leases continues to be a fascinating subject. As the technology of the exploration industry changes, new issues continue to arise and conflicts continue to result. But without this document, the oil and gas industry in the U.S. might never have been born.

June 11, 2012

Lease Ratifications

I have recently been asked to review requests for lease ratifications sent to my clients, and I thought that ratifications would be a good topic for this site.

Companies generally ask owners of royalty and non-executive mineral interests to ratify oil and gas leases covering the lands in which they own an interest. The companies ask for the ratification because they want the right to pool the royalty or non-executive mineral interest covered by the lease. In Texas, even though the holder of the executive right (the right to lease) has the right to negotiate and grant leases covering the interests of royalty and non-executive mineral owners, the holder of the leasing right does not have the right to grant the lessee the right to pool those interests (unless that right was expressly granted or reserved in the instrument creating the royalty or non-executive interest). In order for a pooled unit to be effective as to a royalty or non-executive mineral owner's interest, the owner must either agree to the pooled unit or grant the lessee the right to pool his/her interest.

A non-executive mineral owner is the owner of a mineral interest who has given up the right (by conveyance or reservation) to lease his/her interest. The non-executive mineral owner has the right to receive his/her share of any bonus and royalty paid pursuant to the lease granted by the holder of the leasing right.

Ratification of a lease by a royalty owner or non-executive mineral owner may or may not be in his/her best interest, depending on the circumstances. If you own a royalty or non-executive mineral interest and are asked to sign a lease ratification, you should first ask for a copy of the lease you are being asked to ratify. You should determine whether the lease covers only the acreage in which you own an interest or also covers additional acreage in which you own no interest. If the lease covers lands in which you own no interest, you should be sure that you understand the effect of the ratification. That will depend on the language in the lease. You should confer with an oil and gas attorney about the legal effect of the ratification.

You should also determine whether a well has already been drilled on the lease (or on a pooled unit in which the lease is included). Companies should obtain lease ratifications before wells are drilled, but they often do not. If a well has already been drilled and if it is located on the tract in which you have an interest, there is usually no benefit to you to ratify the lease, and the result might be that your interest is unnecessarily diluted by a pooled unit that you have not consented to. If the well is not located on your tract but is in a pooled unit in which your land is included, you will not share in production from the well unless you ratify either the lease or the pooled unit.

Finally, if you own a non-executive mineral interest and are entitled to a share of the bonus paid for the lease, you should be sure that you get your share of the bonus. The entire bonus may have been paid to the owner of the executive interest, in which case you have a claim against the executive interest owner to get your bonus share. Or the company asking for the ratification may have taken and recorded the lease but not paid you your bonus share. A company landman may tell you that you are not entitled to get your share of the bonus unless you ratify the lease. This is not correct. You are entitled to your share of the bonus whether or not you ratify the lease.

Lease ratifications are legally binding documents, and owners should be sure that they understand the legal effect of the instrument before signing.

December 7, 2011

Dealing With Landmen

Ian Urbina, the New York Times reporter who has written several articles recently about oil and gas exploration and the perils of hydraulic fracturing, recently wrote an article, "Learning Too Late of Perils in Gas Well Leases," that appeared on the front page of the Times on December 2. In research for the article the Times obtained and reviewed more than 111,000 oil and gas leases covering lands in Texas, Maryland, New York, Ohio, Pennsylvania and West Virginia - a remarkable effort. Urbina's article points out several ways in which the leases fail to protect the interests of landowners:

-- They do not require companies to compensate landowners for water contamination.

-- They do not address well locations, destruction of trees, or other surface use issues.

-- They do not disclose environmental risks and liabilities.

-- They allow extensions of the primary term without landowner approval.

-- They don't contain Pugh clauses requiring release of lands not included in units.

-- They don't require the operator to test the quality of nearby water wells before commencing operations.

Urbina also discusses the pressure tactics employed by some landmen to convince owners to sign leases.

As a lawyer representing landowners in lease negotiations, I consider Urbina's article a good advertisement for why owners should retain attorneys to help them with their leases. The article also got me to thinking about my experience with landmen and their style and tactics in obtaining oil and gas leases. I thought it might be a good topic for this venue.

My experience with landmen is principally in Texas, where landmen have been practicing for many years. In general my experience has been good; when dealing with me, landmen generally are professional, avoid pressure tactics, are not misleading, and value their reputation for fair dealing and veracity. As with any profession (including attorneys), there are exceptions. I have learned to spot landmen who do not live up to professional standards.

My advice to landowners dealing with landmen:

First: Find out who the landman works for. Exploration companies usually hire groups of independent landmen on a contract basis to research title in an area and acquire leases from mineral owners on behalf of the company. Sometimes the landman will acquire the lease in the name of their landman group rather than in the name of the company for whom they are working. The company may want to keep its presence in the play confidential for as long as possible, to avoid escalation of bonuses. My advice is to insist that the real party in interest be disclosed.

Second: Don't be afraid to ask questions. Why is the company leasing in this area? What other companies are leasing in the area? How much acreage has the company acquired so far? What other leases does the company have covering adjacent lands, or other undivided interests in the same tract? How did the landman determine the mineral interest I own? What kind of wells are likely to be drilled - oil, gas, horizontal, depth? Are there any recently drilled wells in the area? Particularly if you are not certain about your ownership, this is the opportunity to get good title information about your interest. Get the landman to explain to you how you came to own the interest that he/she wants to lease. Ask for copies of the relevant documents.

Third: Do your homework. Don't take the landman's information for granted. If you know other landowners in the area, find out what they know. Find out what wells have been drilled so far in the area and their rates of production. Go on the web and check out the company. If there are any publicly owned lands in the area, find out if they have been leased and what lease terms were negotiated.

Fourth: Understand the lease you have been offered. If you need help, get it. You wouldn't sell your land without professional help - why should you sign a lease, which might have much more financial value than a sale, without professional assistance?

Fifth: Investigate state and local laws relating to oil and gas exploration and development. Some states have laws requiring the company to compensate the surface owner for uses of and damage to the land. State laws regulate well spacing and pooling. Local ordinances may affect well locations, drilling practices and well production activities.

Sixth: If you feel that the landman with whom you are negotiating is not being helpful or truthful, ask to speak to his boss, or to a company representative. Companies know that landmen are representing them, and the company should be told if a landman they hired is engaging in unhelpful or unethical negotiation tactics.

Seventh: Don't get in a hurry. Landmen often leave the impression that you may lose the opportunity to lease if you don't sign up soon. That is seldom the case. To be a good negotiator you must leave the impression that you can take it or leave it, depending on whether you get the terms you want. Don't make or accept an offer unless and until you are confident that you will be happy with it.

Urbina's article mentions two websites as helpful to landowners negating leases. One of these, Landman Report Card, is an interesting effort by the Center for Future Civic Media at Massachusetts Institute of Technology, in collaboration with the Oil and Gas Accountability Project. It allows individuals who have had good or bad experiences with a particular landman to post their experiences and grade the landman's performance - along the same lines as Angie's List. It appears to be just getting off the ground - there are only a few posts so far, and there are thousands of landmen now working to acquire leases, from Pennsylvania to Ohio to Colorado. The other is PAGasLeases.com, which focuses on leasing in the Pennsylvania Marcellus Shale.

Landmen have resisted efforts at mandatory licensing of the profession, so there is no requirement that they have any particular skills or education. Anyone can call him or herself a "landman" and jump right in. Particularly in new areas such as the Marcellus and now the Utica and Antrim plays in Michigan and Ohio, I suspect that companies have hired people as landmen who have very little experience. The best landmen are members of the American Association of Petroleum Landmen, which has developed ethical standards that all of its members must agree to abide by. AAPL has very good education programs for its members and certifies landmen as having met certain education requirements and professional qualifications. If you have bad experiences with a landman who is an AAPL member, you can report such conduct to the AAPL.

In general, I have found landmen to be an interesting group - independent, gregarious, friendly, and knowledgeable. Just remember that their job is to acquire a lease with the lowest bonus and royalty that they can negotiate for their client, the company. They are not representing your interest. Be courteous, but be smart.