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Texas Supreme Court Opines on Retained Acreage Clauses

Last Friday the Texas Supreme Court issued opinions in XOG Operating, LLC v. Chesapeake Exploration Limited Partnership et al., No. 15-0935, and Endeavor Energy Resources, L.P. et al. v. Discovery Operating, Inc. et al., No. 16-0155.  In both cases, the Court affirmed the decisions of the trial courts and courts of appeals.  Both cases garnered substantial attention from the industry, as evidenced by amicus briefs from the Permian Basin Petroleum Association, the Texas Independent Producers and Royalty Owners’ Association, the Railroad Commission and the Texas Oil and Gas Association, among others.

Both cases construe retained acreage clauses. The opinion in Endeavor includes a good explanation of the purpose and effect of retained acreage clauses, the purpose and operation of field rules and proration units, and the interplay between the two. I summarized the facts and results in both of these cases when the Supreme Court granted the petitions for review. My prior post can be viewed here.   I have also previously written about the relationship between field rules and retained acreage clauses. I’ve said that it is a mistake to rely on field rules and proration units to determine how much acreage can be retained under a retained acreage clause; these cases illustrate why that is so.

One comment on Endeavor:  the field rules applicable in that case were for the Spraberry (Trend Area) Field. Those rules provide for “standard” proration units of 80 acres but allow the operator to assign up to 160 acres to a well, with a corresponding increase in its allowable rate of production. The allowable rate for a well on an 80-acre proration unit is 515 barrels per day.  The retained acreage clause provided that the lease would expire except for the “proration unit assigned to a well,” and that each proration unit would “contain the number of acres required to comply with” Railroad Commission rules “for obtaining the maximum allowable.” Endeavor assigned 80 acres to each of four wells, and Discovery said the lease expired except as to those four proration units “assigned” to the wells. Endeavor argued that it was entitled to 160 acres per well because that amount of acreage was necessary “for obtaining the maximum allowable.”  The Supreme Court agreed with Discovery.  In discussing Endeavor’s argument on the “maximum allowable” language, the Court quotes from two CLE papers:

To retain 160 acres per well, Endeavor needed to actually assign 160 acres to each well. Rule 3 [of the field rules] provides that Endeavor could have attempted to assign to each of its existing proration units an additional 80 acres of “tolerance acreage.” Although such an assignment would hypothetically raise each well’s maximum producing allowable, when productive acreage is a component of the maximum producing allowable — as it is here — the operator must “verify[] that additional acreage is actually necessary or required to achieve the maximum allowable.” Phillip C. Mani, Interpreting and Drafting Retained Acreage Provisions–Partial Termination of Leasehold Rights, State Bar of Tex. Oil, Gas & Mineral Title Examination Course, at 6 (2015). Indeed, if a well “is draining a certain amount of acreage, but the operator intends to claim more than that amount, the operator may open itself up to claims that it is not acting in good faith in purporting to retain a substantially greater amount of acreage.” Id.; See also [C. Scott Petry, Drafting the Retained Acreage Clause: The Effect of Governmental Authority on Retained Acreage, State Bar of Tex. Prof. Dev. Program, 7th Annual Advanced Oil, Gas and Energy Resources Law Course 3 (2009)] at 4 (“If the technical evidence clearly show that the well is draining eight (80) acres, but the client operator is claiming three hundred twenty (320) acres under the maximum allowable, that client may open itself up to claims that it did not act in good faith in retaining the full 320 acres.”)  Of course, this question is not directly before us, as Endeavor did not assign any tolerance acreage to its proration units.

The Court quoted evidence from the record revealing that Endeavor’s wells were not capable of producing near their maximum allowable of 515 barrels for their 80-acre proration units. The Court, it seems to me, has deliberately included the above discussion to raise at least the possibility that a landowner would have a claim if an operator assigns tolerance acreage to a retained acreage unit when it is not necessary for the well to produce at its maximum efficient rate under the allowable assigned to a “standard” proration unit for the well.

Some field rules now provide for optional assignment of acreage for horizontal wells greatly in excess of the amount of acreage that can be drained by the well. If a retained acreage clause allows an operator to assign the amount of acreage “necessary to obtain the maximum allowable,” and if the well is not capable of producing at the maximum allowable rate, the Court’s language indicates that it may recognize a claim that the operator designated the “maximum allowable” acreage in bad faith.

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