Articles Posted in The Oil and Gas Lease

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With the drop in oil prices has come a wave of litigation over underpayment of royalties. Multiple suits have been filed against Repsol (formerly Talisman) over its royalty payments in the Eagle Ford. Multiple suits against Devon for royalty underpayment have been consolidated into a multi-district docket in San Antonio. A federal court in Fort Worth has certified a class action against Devon for underpayment of royalties in the Barnett Shale. Conoco is settling class actions brought in Oklahoma that also cover class members in Texas. These suits allege underpayments of royalty on oil and gas. The San Antonio multi-district suits also allege breach of lease provisions requiring the lessee to protect the lease against drainage from wells on adjacent properties.

These cases present opportunities for plaintiffs’ attorneys to earn large contingency fees. They also point out the problems faced by land and mineral owners in determining whether their lessee is complying with their oil and gas lease. What should landowners do to monitor lease compliance?

There are no easy answers to these questions. Below are some suggestions.

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The Texas Land & Mineral Owners Association Newsletter recently published an article disclosing that the Zavala County Appraisal District has denied agricultural-use special appraisal value for land used for oil-pad sites and frac ponds. One owner who challenged the re-appraisal got the District to agree that, if a well pad is not fenced, it won’t deny the ag-use appraisal for pad sites. But fenced frac ponds, it said, don’t qualify.

When there is a “change of use” of land classified as ag-use or open-space use, the law provides that the change of use results in a “roll-back” of property taxes for five years. The owner is assessed tax based on market value for the five years, plus interest at 7% per annum. This can be a big hit for property owners. For one property owner in Zavala county, the assessed property value went from $73/acre to $2,000/acre. And, once a special use value is denied, it may take years after the oil company ceases its use of the property before the owner can re-gain the special use value.

Landowners should consider a lease provision shifting the risk of this re-appraisal to the lessee. Such a provision might read as follows:

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Modern oil and gas leases often contain provisions that have come to be known as “retained acreage” clauses. Such clauses require the lessee to release acreage not assigned to a producing well at the end of the primary term, or at the end of a continuous drilling program conducted after the primary term. One commentator has said that the purpose of a retained acreage clause is to “replace the lessor’s need to utilize the implied covenant of reasonable development as the sole means to see that its  acreage is fully developed.”  Bruce M. Kramer, Oil and Gas Leases and Pooling: a Look Back and a Peek Ahead, 45 Tex. Tech L. Rev. 877, 881 (2013).

There is no standard form of retained acreage clause. Lawyers representing lessors have developed their form of the clause, and the clause is often one of the most heavily negotiated provisions of an oil and gas lease.

Two court opinions have recently construed retained acreage clauses.

In ConocoPhillips Company v. Vaquillas Unproven Minerals, Ltd., 2015 WL 4638272 (Tex.Ct.App.-San Antonio Aug. 5, 2015), the lease provided that, at the end of the lessee’s continuous drilling program,

Lessee covenants and agrees to execute and deliver to Lessor a written release of any and all portions of this lease which have not been drilled to a density of at least 40 acres for each producing oil well and 640 acres for each producing or shut-in gas well, except that in case any rule adopted by the Railroad Commission of Texas or other regulating authority for any field on this lease provides for a spacing or proration establishing different units of acreage per well, then such established different units shall be held under this lease by such production, in lieu of the 40 and 640-acre units above mentioned.

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Modern oil and gas leases often contain restrictions on the right of the lessee to assign the lease to third parties. The lease may require the consent of the lessor to any assignment, or it may impose conditions on the right to assign — for example, that the lessee retain an interest in the lease and/or remain operator.

Recently I received a draft of an article that will be published next year in the Buffalo Law Review addressing the validity of restrictions on assignments in oil and gas leases, and the authors asked that I make it available on this blog. It is titled “The Validity of Restraints on Alienation in an Oil and Gas Lease,” and it is authored by  Luke Myer and Rory Ryan, professors at Baylor Law School. There are actually two draft articles, one explaining the issue in layman’s terms and a second providing a more scholarly legal analysis with citations. The second article is titled “Aggregate Alienability.” The articles I think give a good analysis of the issue. There is actually little authority on whether restrictions on assignment, or “restraints on alienability,” in an oil and gas lease are valid. The authors make a good argument that such restrictions are valid. Good information for oil and gas lawyers, including tips on how to draft restrictions that are more likely to be upheld and enforced. The draft articles can be viewed here and here.

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Over the last 100 years courts have developed a body of case law in disputes between lessors and lessees of oil and gas leases. Courts have held that certain provisions are “implied” in the contracts, even though there is no language in the lease to support those provisions. The rationale behind these implied provisions goes back to cases interpreting hard mineral leases, and back to the cradle of the oil industry, Pennsylvania. The idea behind these implied provisions is that they are necessary for both parties to get the benefit of their bargain and to make the lease work as intended. Because the lessee has control over what operations are conducted under the lease, most of these implied provisions are intended to benefit the lessor, who generally has less bargaining power in negotiation of the lease and no say in whether and how the lease is developed.

An example: oil and gas leases generally provide that the lease will remain in effect for the primary term and for as long thereafter as oil or gas is produced from the leased premises. Courts have implied a requirement that, for the lease to remain in effect, the production must be in “paying quantities.” The production must be sufficient for the lessee to realize a profit over operating costs.

Another example: what if the well on the lease temporarily ceases production at some point after the end of the primary term. Does the lease terminate, even if the well can be repaired and restored to production? Courts developed the implied provision that a “temporary” cessation of production will not cause the lease to terminate, as long as the lessee acts with reasonable diligence to restore production.

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The only three essential terms of an oil and gas lease are the granting clause, including a description of the property, the habendum clause, which defines the term of the lease, and the royalty clause. The following would be a valid, enforceable lease:

John Doe hereby leases to Gusher Oil Company the oil and gas in and under Section 5, Block 4, T&N RR Co. Survey, Jones County, Texas, for the purpose of exploring for and producing oil and gas. This grant shall be for a term of three years and as long thereafter as oil or gas is produced from the property. John Doe reserves a royalty of 1/4th of all oil and gas produced and saved.

Dated ___________________, 2014

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An essential element of any oil and gas lease is a description of the land to be covered by the lease. The test for a legal description is that it must contain, or make reference to recorded documents that contain, a description of the land of sufficient specificity that a surveyor could locate the property on the ground with reasonable certainty.

The lease itself can contain a metes and bounds description from a survey, or (more commonly) it can refer to an earlier recorded document that contains a metes and bounds description of the property. Sometimes descriptions have to be cobbled together from two or more other descriptions. For example: “All of that certain 100 acres of land described in deed from John Doe to Robert Smith recorded at Volume 99, page 99 of the deed records of Karnes County, Texas, save and except 10 acres of land described in deed from Robert Smith to Mary Jones recorded at Volume 100, page 100 of the deed records of Karnes County, Texas.”

There are other ways to adequately describe a tract. The test is whether the surveyor can use the description to locate the property.

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In Texas, an oil and gas lease grants to the lessee the fee mineral estate in the leased premises for the term of the lease. The lease provides for an initial term during which the lessee need do nothing in order to keep the lease in effect — called the “primary term.” Thereafter, the lease terminates unless the lessee is producing oil or gas or conducting operations in an effort to discover and produce oil or gas. If the lease remains in effect beyond the primary term, the remaining time the lease is in effect is called the “secondary term.” A typical lease will provide that

“This lease shall remain in effect for a term of three (3) years (the primary term) and as long thereafter as oil or gas is produced from the leased premises or operations, as provided herein, are being conducted on the leased premises.”

The primary term can be one month or ten years or more. Today, most leases provide for a three-year primary term. If no production or operations take place during the primary term, the lease terminates automatically and the mineral estate reverts to the lessor.

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I got the idea for starting this blog from a presentation I made at a meeting of the Texas Land & Mineral Owners’ Association, titled “Checklist for Negotiating an Oil and Gas Lease.” TLMA posted the outline of my presentation on its website. I soon began receiving calls from people who had found the article on the net. I had no idea that the article had found its way to the net, but the popularity of the checklist led me to believe that landowners might profit from other articles of interest to them on matters related to oil and gas exploration and development.

The oil and gas lease is the foundational document on which the oil and gas industry in the US is based. Its form and provisions have been modified and shaped over the years to respond to changing industry practices and developments in the law, but its essential form has remained unchanged since the latter half of the 19th century. It is one of the most commonly used and successful legal documents in US commerce.

So, I thought it would be a good idea to write a few posts focused on the oil and gas lease, of which this is the first.

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