OIL AND GAS OUTLINE – PROFESSOR REED
FALL 2000
I. INTRODUCTION
A. Horton’s Rule:
1. In Oil and Gas law courts are extremely
reluctant to parole evidence into an oil and gas instrument. “I said what I meant and I meant what I
said.”
B. History:
1. Col.
Drake hit first oil well in 1859 at 69 feet.
C. Oil
Formation and extraction:
1. Where oil is found: Oil is rarely found in open containers
underground. It is found in sedimentary
rock.
2. How oil is formed: Exoskeletons of micro organisms settle and
guts decay. Pressure combined with
temperature converting the guts into oil.
Skeleton (bone) turns to rock.
3.
Recovery methods:
a. Primary recovery: just pump oil out. Get 25% of oil in field.
b. Secondary Recovery: pump salt water in to push oil out. Get
50% of the oil in the field.
c.
Tertiary: pump in detergents to push oil
out and wash formation out. Get 75% of the oil. No other used because costs more to get than
can sell the oil for. Examples: pump in
steam to make oil thinner, set reservoir on fire with injection wells to inject
oxygen and fire heats oil, making it thinner, inject carbon dioxide which
expands and pushes oil out.
D. Oil and Gas ownership:
1. Crown
Rule - minerals belonged to the Crown.
a.
i. minerals
ii. marital property
iii. common law procedure
2. Common law - no one owns wild animals.
3. Donkey Rule:
get to determine who uses property.
Can’t do whatever you want with it.
II. RULE OF CAPTURE:
A. In the beginning of oil and gas law, you had
the standard heaven to hell rule that you own everything from the center of the
earth to the heavens. This was not an
effective rule for the oil and gas industry, so the rule of capture was
developed - at the time, it was believed that oil and gas migrated.
B. Rule
of Capture (only applies underground):
1. Del
Monte Mining v. Last Chance Mining:
The owner of a tract of land overlying an oil and gas reservoir has the
right to capture all the oil and gas he brings to the surface through wells
located on his own property, even though the oil may be drained from his
neighbors tract.
a. The only remedy at common law for an adjacent
landowner to protect their land from drainage was to drill their own well (rule
of convenience).
b. Kelly
v.
C. Consequences
of the rule:
1. Encourages prolific drilling and rapid
production (operating wide open).
2. physical and economic waste such as
overdrilling and over-production.
D. Reinjected
hydrocarbons:
1. Champlin
Exploration v. Western Bridge: hydrocarbons
which have been severed from the ground and are reinjected are not subject the rule of capture. Severed hydrocarbons are personal property
and not real property - like they were prior to extraction- and are subject to
the law of abandonment.
a.
To abandon, must:
i. intend to abandon
ii.
and intent corroborated by some kid of physical act (Ex.: toss it out).
Absence of owner taking steps to recover it does not indicate abandoned.
b. Must show damage to your real estate to get
trespassory damages for reinjected
minerals that escape onto your land. Get
nominal damages unless you can show actual damage to your land.
2. Texas
American Energy v. Citizen Fidelity Bank & Trust: Gas extracted and piped from
a.
b. MAJORITY RULE: reinjected gas does not become subject to the
rule of capture.
E. RULE
OF CAPTURE AND TRESPASS:
1. Geo
Viking v. Tex-Lee Operating Co.: Can’t
get damages for loss of oil that would have been trespass had you actually
removed it. Fracturing across property
lines is a surface trespass and you can’t get damages for oil not retrieved due
to failure of the fracturing process.
Trespasser can’t claim under the rule of capture.
F. LIMITATIONS
ON THE RULE OF CAPTURE:
1. Conservation Statutes: to prevent physical and
economic waste and protect correlative rights.
a. What
conservation statutes do:
i. Well Spacing Rules: prevent overdriling by limiting the number of well that can be drilled in a given
area (based on acreage). Exceptions to
the well spacing are often necessary.
Texas Statewide spacing rule is 40 acres (Rule 37), but field rules can
differ.
ii. Production limitations (prorating): limits the amount of oil and gas a well can
produce.
iii. Compulsory Pooling: allows a drained landowner to force neighbors
to share their well’s production.
iv.
Density controls: how may acres
to support one well.
2.
Correlative Rights:
a. Waste or wasteful production techniques will
bring liability, as will negligent damage to the ability of the producing
formation to produce for others.
b. Provides that each owner of a minerals in
common source of supply has the right to a fair chance to produce oil and gas
from the reservoir. Even if statute does
not mention correlative rights and waste, they must be implied.
i.
c. Denver
Producing & Refining Co. V. State:
Allowed gas-oil ratio of 2000 cubic feet per barrel of oil. Plaintiff seeks an increase in the ration to
5000. Average for the field is
1895. As oil moves out of the ground,
gas bubbles out of ground too. Prior to
the 1950’s technology not competent to recover and pipe natural gas.
i. preventing waste is more important than
correlative rights if have to choose.
d. Examples of Correlative rights:
i. Right to be protected from negligent
operation: Eliff: wells blew out,
cratered, and ignited. This was
considered waste. Party injuring
reservoir can not claim benefit of the rule of capture.
ii. Exxon
v. Railroad Commission: BTA drilled
to Ellenberger formation, but found nothing.
They plugged back to the Montoya, but it was near depletion. They want to plug back to the Devonian
formation. If they had originally
drilled with the intent of tapping the Devonian formation, spacing requirements
would not allow it. Exxon had a well
pulling from the Devonian formation, but it was not capable of extracting all
of the oil.
a. Test:
whether the existing well was drilled and completed in original formation legitimately and in good
faith, not as a subterfuge to bolster a later Rule 37 exception. Exception granted to prevent waste.
b. MER - Maximum Efficient Rate at which a well
can produce without impairing efficiency of the reservoir. Maintain reservoir
pressure as long as possible. Start here
to prevent tarring out effects.
3. Fair Share Rule:
a.
Wrongski v. Sun Oil Co.: Sun
Oil drilled several wells on nearby property within the field. Oil and gas conservation statute said one
well per 200 acres and limited production to 75 barrels of oil per day.
i. Fair share - each owner entitled to his
equitable and ratable share of recoverable oil and gas in a common pool in
proration of recoverable reserves underlying his and bears to recoverable
reserves in the entire pool. Also known
as correlative rights.
a. State in exercising its conservation power
may not do so in a way denying property owner a fair chance to produce his just
and equitable share of the oil and gas under his land. Limits conservation power.
b. Pickens
v. Railroad Commission: owners of
wells with thicker acreage (must drive further down to get to oil) wanted
production apportioned on acres/ feet because could get more credit. Thin owners (because oil pushing toward
thicker owner die to water rushing in) wants apportionment base on percent
acreage.
i. straight surface acreage allocation is the
most common unless utilization for enhance recover is involved in which case
formulas may be very complicated.
ii.
Substantial evidence that thin owner would not be able to
produce unless give credit for acreage.
Upheld a 50-50
apportionment.
4. One Well as a Matter of Right: if own land
and can’t place a well on it due to the spacing rules, if property in separate
ownership before 1916, then you are entitled to one well. If not separately owned until after 1916, but
carved out without any concern for minerals, then probably has right to one
well also.
a. Grounds for overruling an agency decision
(spacing rules):
i. claim order violates a statute
ii. claim order not supported by substantial
evidence in the record
II. LEASES
A. Property
Interests:
1. Fee interest - ownership of both the surface
and the mineral rights in a fee simple absolute.
a. A conveyance of land or all minerals conveys
every stick the grantor owns, except what you specifically reserve.
2. Surface interest: what remains in the bundle of rights with the
landowner after the mineral interest has been severed. It is all the rights that are not included as
part of the mineral interest.
a. landowner has a possibility of reverter, a royalty, and no responsibility for drilling or
maintenance fees.
3. Mineral interest: held by the owner of the minerals. Could be owned by the surface owner of could
be sold separately.
a. The rights held by the mineral interest:
i. right to enter and drill
ii. right to lease (executive right)
iii. right to receive the bonus (cash
consideration for the lease)
iv.
right to receive delay rentals
v. right to receive royalties (in best interest
to convey only this)
b. A conveyance of 1/16 of the minerals in and
under this land = 1/16 of the
minerals which is 1/16 of the 1/8
c. A conveyance of 5/8 of minerals in and under
the land reserving 4/8 = reserved
3/8. should have said reserved 1/2.
d. profit a pendre state - no ownership of
minerals until it is reduced to your
possession. Right to go on and get oil
is only right until oil is
removed.
e. To convey a mineral interest,
it must say “in and under the following
lands.”
f. Ownership in place - ownership
exists while oil is in the ground.
g. Be careful to exclude from a conveyance any
right that you want reserved or a conveyance of that right will be implied by
your failure to reserve - Anderson v.
Mayberry.
4. Leasehold interest: generally what is granted in an oil and gas
lease. The right to mineral interest
granted by an oil and gas lease. Also
called the working interest.
a. the usual oil & gas lease conveys a fee
simple determinable from
the lessor to the lessee. A mineral deed
actually conveys a fee simple to the grantee.
b.
a fee simple determinable may last forever, but is subject to automatic
termination upon the occurrence of certain conditions imposed by the lease.
c. Hunt
Oil v. Kerbaugh: unless language
says otherwise, lease gives oil and gas owner he right to make reasonably
necessary use of the surface to produce, drill for, develop, and explore oil
and gas. No duty to clean up when you
are done except in
i. Most leases today contain a clause
prohibiting operation within X feet of buildings, but applies only to buildings
on property at time of the lease unless says includes buildings hereinafter
constructed or get lessee to release the area around
the building. Is also common practice to
just go to the landowner and purchase a release of damages.
ii. Accommodation right - mineral owner’s right
to the surface is primary. But where
surface owner’s use of surface will be
effected and other options exist on the property,
must use method of least interference.
To modify the reasonable necessary provision, must have all three of the following:
a.
pre-existing use - lessor doing this before lease was taken.
b.
lessee wants to interfere
c.
lessee has reasonable alternative on the lease
iii. If lessee acting sloppily, maybe action at
common law under Environmental Torts:
nuisance, molecular trespass.
5. Royalty
Interests
a. a nonpossessory , cost free right to a share
of the gross production or a share of the proceeds from the sale thereof. It is a real property interest in
b. Royalty does not have the right of surface
use, the right to lease, and does not share in the benefits of the lease -
bonus, delay rental, or royalties - unless have a leasehold royalty.
c. Types:
i. Landowners Royalty: the fractional share of production payable to
the lessor in the royalty clause in the lease. Usually 1/8, but can be
higher. Also called a leasehold royalty.
ii. Overriding Royalty: carved out of the lessee’s interest. Where a lease is assigned and an overriding
royalty is reserved. Ends when lease
terminates.
iii. Nonparticipating Royalty: carved out of the mineral interest that
entitles its holder to a stated share of production without regard to the terms
of any lease, though it is frequently measured by a leasehold royalty. Granted by the lessor. All you own is a royalty interest.
iv. Term Royalty: royalty interest carved out of the mineral
interest for a specific term, which may be fixed for X # of years) or defeasible (for X # of years and so long
thereafter as there is production for the premises).
v. Perpetual Royalty: a royalty that may be extended forever; it is not limited in time.
vi. Mineral Royalty: similar to a defeasible term royalty in a
common law state; it is subject to prescription for nonuse and will terminate
in 10 years if production does not occur.
d. A lease royalty is created by the lease
clause and expires with the lease. The
landowner gets the royalty stick back when the lease expires.
e. A conveyance of 1/2 of the royalty in and
under this land = 1/16 of gross production.
The entire royalty is 8/8, so 1/2 = 1/16. This royalty will fluctuate depending on the
marked, but never lower than 1/16.
f. A conveyance of 1/16 royalty is now accepted
as meaning 1/16 of the 8/8 royalty or 1/2 of it. This locks then in to 1/16 and it does not
fluctuate.
g. A conveyance of “1/160th part of all oil, gas, petroleum, sulfur,
and all other minerals that are produced and saved from the following lands” =
a conveyance of a royalty interest - Barker
v. Levy. You only have the right to
go in and get it.
6.
Requirements of a Conveyance:
a. name of grantor
b. words of grant - hereby grant,
sell and convey are magic words
c. name of grantee
d. description of the land
e. signature of the grantor
f. acknowledgment - if eligible to be recorded,
it must contain this - verification that
this is a true conveyance to provide notice to
subsequent purchasers
g. delivery - to party or their
agent.
7. You can’t convey what you don’t have. Even if you execute a deed, it is void. An attempt by grantor to convey more than he
has passes only what the grantor has.
IV. THE OIL & GAS LEASE
A. Purpose:
1. Lessee seeks the right to develop the leased
land for an agreed term without any obligation to drill. If production is obtained, the lessee wants
the right to maintain the lease for as long as is profitable.
2. Lessor wants the lessee to find and produce
oil because will allow him to collect his royalty.
B. The
basic clauses:
1. The
Granting Clause:
a. defines what right are give by the lessor,
describes the property, sometimes covers specific substances, often contains a
“mother hubbard clause” which provides that the grant will cover other lands owned or claimed by the
lessor in the area, even if they
are not specifically described.
i. In Tex., protects the lessee against
inaccuracies in a legal description caused by incorrect surveys, careless
location of fences, or other such mistakes, but does not act to convey large
tracts of land the parties have not chose to grant in the lease.
C. Habendum Clause: “The lease shall be for __ years from this
date (called the primary term) and as long thereafter as oil and gas, or other
minerals are produced.”
1. Primary Term: Sets the maximum period lessee can keep the
lease without drilling. Fixed period
during which the lessee will have no obligation to conduct drilling operations
and secure production on the property. - unless the lease was being drained and
that would be covered in a covenant.
a. If lessee chooses not to drill during the
primary term, he will still have to pay delay rentals to keep the lease in
effect.
2. Secondary Term: created by the language “as long thereafter
as oil, gas, or other minerals are produced.”
MAJORITY RULE: With only a
habbendum clause, you can’t wait until the last day of the lease to drill. Must drill and have production before the
primary terms ends (TX, LA, NM, MI, OH, IL).
a. Requirement of Production:
i. Actual production is required by most states
to extend a lease into the secondary term.
ii. MINORITY view: lease will not terminate if oil and gas is
discovered prior to the end of the primary term (OK,
b. How much production:
i. Unless lease says “whether or not paying
quantities”, must produce in paying quantities.
Two part test:
a.
have the operations been profitable?
1.
revenues from sale of product are greater than operating costs.
a. operating costs v. capital costs
i. predictability - expected or periodic
indicates operating
ii. Is it something new - if so, capital
iii. Size and cost - the higher, more likely to be
capital
iv.
Nearness in time to drilling operations tends
to show a capital expenditure.
v. Does it
extend the life of the well? If so, tends
to look like a capital cost. Pshigoda v. Texaco: costs of reworking the well are capital and not
deducted from profit.
b. Stanolind Oil and Gas v. Banhill: Paying quantities
requires that production occur prior to the
end of the primary term. If no market
for sour gas
at the time it is extracted, no gas is being sold,
therefore, no production and the lease expires.
b. Would a
REASONABLE PRUDENT OPERATOR continue
to operate the lease? (applies even if appears
to be operating at a loss.)
i.
ii. factors:
depletion of reservoir and price for which lessee is able to sell his
product, relative profitableness of other wells in the area, operation and
marketing costs of the lease, net profit, lease provisions, reasonable period
of time under the circumstances, and whether or not lessee holding lease for
speculative purposes.
iii. If all you have is de minimus production, but
want to keep the lease, need to get landowner to agree to amendment.
c.
Temporary Cessation Doctrine - once actual production and
marketing in paying quantities have been established, a temporary cessation of
production, due to a sudden stoppage of the well or some mechanical breakdown
of the equipment, or the like, will not terminate the lease if the lessee
exercises diligent efforts to restore production and there is a reasonable
expectation of success within a
reasonable period of time. Usually about 60 days - Pack v. Sante Fe Minerals.
Lease to continue after primary term as long as production does not
cease for 60 days without resuming. BUT
must actually have production before can have cessation. A well that has never produced can not cessate -
1. Court considers three factors: duration of cessation - longer the time more
likely to be permanent; cause of the cessation - if not within lessee’s control
most likely temporary; lessee’s efforts to restore production - if slow to act,
cessation most likely permanent.
a. Arkansas Supreme Court held that a cessation of production for more than 4 years as
the result of a fire at the well was temporary.
Saulsberry v. Siegel. This is most likely the outer limit of a
temporary cessation.
b.
2. Savings Clause - To avoid litigation
over what “temporary” means and how long
is a reasonable time to restore production.
It specifies that a cessation of production will not cause the lease to
terminate as long as the lessee commences corrective work within a stated
period of time, like 60 to 90 days.
3. when you have two or more defensive clauses
with different time periods, to be safe,
should operate under the shorter time period, or to be even safer make the time
periods all the same.
d. Shut-in Royalty Clause - permits the
lessee to maintain a lease upon which
wells are shut-in (capable of producing but are not) by payment of a shut-in
royalty. “While there is a gas well or
wells on the land covered by this Lease or acreage pooled therewith, whether it
be before or after the primary term hereof, and such well or wells are shut-in,
and there is no other production, drilling operations, or other operations
being conducted capable of keeping the Lease in force under any of its
provisions, lessee shall pay as royalty to lessor (and if it be within the
primary term hereof such payment shall be in lieu of delay rentals) the sum of
a $1 per year per net mineral acre, such payment to be made to the depository
band hereinafter named on or before the anniversary date of this Lease next
ensuing after the expiration of 90 days from the date such well or wells are
shut-in, and thereafter on the anniversary date of the Lease during the period such
wells are shut-in, and upon such payment it shall be considered that this Lease
is maintained in full force and effect.”
1.
well must be capable of producing if paying quantities
a. A shut-in well is when the control valves of
a producing well are turned to the stop production.
2. most often occurs where a well is completed
but is just waiting for a market
a. If the clause’s language does not limit its
use - by referring to lack of market or pipeline connections, for example - the
clause should be held applicable whatever the cause of the shut-in so long as
the lessee acts for a good faith business purpose.
3. need this to prevent the lease from
terminating at the end of the primary term, even when the well is capable of
producing (TX, NM).
4. provides for constructive production,
typically in the form of shut-in royalty payments.
5. failure to make the shut-in royalty payments
will result in the termination of the lease
6. If you have a 60 day clause and a 90 day
grace for shut-in, 60 day clause wins and you must pay within 60 days. That is why
you want operations habendum.
7. If you shut-in clause doe not specify the
time that the shut-in payment is due, payment is due before the well is
shut-in. Pay as near to shut-in as can. May have to consider double payments to be
safe.
8. If you pay the wrong person, you will lose
the lease. Acceptance of royalty
payments, however, does not estop the lessor from terminating the lease. (this
is different from delay rentals).
9. If have a strong shut-in royalty clause,
don’t really need a strong force majeure clause. Make sure you draft it so it applies to both
oil and gas wells.
3. Delay Rental Clause: “if operations for drilling not commenced
within one year from the date of this lease, the lease shall terminate unless
lessee pays delay rentals of $__ to the lessor.”
a. Failure to pay delay rentals
will cause the lease to terminate:
i. failure to pay on or before the due date (on
time)
a. acceptance of a payment late is conduct
inconsistant with expiration of the lease, so lease remains in effect.
b.
clause allowing for mailing of delay rentals - if not delivered on time, lease
still in effect.
ii. in at least the proper amount (right amount)
a. Express clause: If lessee shall on or before the due date,
make a bona fide effort to pay rentals, and such payment is ineffective, (there
is a notice component also) lessee shall be obligated to pay proper rental but lease shall not terminate.
Requires that this clause be placed in the lease and a good faith effort on the
part of the lessee to pay the correct amount or the correct person.
b.
Errors made by bank are not chargeable to the lessee.
c. Schwartzemberger
v. Hunt: paying less than the
correct amount will allow the lease to expire.
iii. to the proper parties (right people)
a. if in doubt, pay each heir the highest amount
that could be entitled to.
iv. in the manner provided (right away)
b. Delay rentals can not be made after the
expiration of the primary term. Only
production in paying quantities will hold the lease after the primary term.
c. This is a condition of title and not a
covenant because it provides options.
The unless for provides lessee with three options: drill, pay, or
lose the lease
d. Humble
Oil v.
e. Clauses that requires lessor to notify the
lessee that the delay rental has not been paid and give him 30 days to remit
payment is repugnant to the delay rental clause and will not be upheld.
f. Drilling Operations:
1. Most leases provide that the lease will be
maintained if the lessee commences drilling operations. Actual drilling is not required. It generally is sufficient if there are some
physical operations on the surface of the land, directly related to drilling,
which are conducted in good faith, provided those operations are diligently
pursued until a well is completed.
ii. road
building and operation to prepare to drill
2. Getting a rig you know is not capable of
drilling an oil well
will not commence drilling. It must be
capable of drilling.
3.
4. Dry Hole clauses - Used to clarify
the payment of delay rentals after the lessee has drilled a dry hole. Always affirms the lessee’s right to maintain the lease for the remainder of
the primary term by paying delay
rentals. A well is not dry if you
actually find something -
5. Operations clause - Used to protect
the lessee against expiration of the primary term while drilling operations are
in progress. Makes drilling operations
the equivalent of production for
the purposes of the habendum clause.
a. Need to be careful in the wording in such
clauses. Some clauses have been written that only permits completion of the operations begun before the
end of the primary term. A better clause would be one that
will permit the lessee to commence
a well before the end of the primary term, abandon
it after the primary term and continue to hold the lease by starting another well within 60 days.
b. If you have an operations habendum, you
don’t really need a 60
day clause.
c. Should you define operations?
i. Without a definition, term is construed
liberally in favor of the
lessee.
ii. If you define it, you are limited to what
you defined. If you go to far, you may have adhesion problems.
6. Force Majeure clause - lists acts of
God and other catastrophes beyond the reasonable control of the lessee that
will excuse the lessee from performing certain acts, which if not performed
would have terminated the lease.
a. Only excuses obligations and habendum is not
an obligation. Force majeure should say
that your primary term is extended during force majeure situations.
b. If you don’t have one, you can’t plead it - Perlman v. Pioneer Limited Partnership. Equity won’t help either because it only
protects against forfeiture and forfeiture would not occur. Lease would just expire.
V. THE LEASE ROYALTY CLAUSE
A. Cost
Free
1. The royalty interest is free of the costs of
development, exploration, and production.
2. Is not
profit-sharing or cost-bearing.
B. Deductions
from Royalty
1. Majority Rule: a royalty may be subject to other costs, like
those subsequent to production such as cleaning, transportation, and pipeline
costs. Oil royalties may also be reduced
for processing costs like pulling out the salt water. Market value at the mouth of the well.
2. Minority (OK. KA, CO): market value does not include transportation
and treatment costs to make it marketable.
C. Failure to pay royalty will NOT
automatically terminate the lease. This
is a covenant, and liability for its breach will be restricted to damages.
1. Government leases may contain a clause
causing automatic termination if royalty is not paid.
D.
Division Orders
1. an agreement by those entitled to share in
production proceeds as to how the funds should be distributed. They are used to protect the lessee from
being caught in the middle of disputes over who should be paid.
2. Division orders are signed by all those who
may claim a share of the proceeds, and they bar the co-owners from suing the
party to whom the division order is addressed if there are subsequent
disagreements over the way in which the proceeds were divided.
3. Lessee liability
a. as a general rule, a lessee or purchaser who
pays according to the amounts warranted
by the division order is protected even though one owner is later found to be
overpaid. However, the underpaid owner
may revoke the order, correct the error, and receive the proper amount in the
future, but may not recover past underpayment from the lessee.
b. Exceptions:
The Texas Supreme court has held a lessee liable for past deficiencies
in royalty payments where:
i. the lessee prepared the erroneous division
orders AND
ii. the lessee was unjustly enriched by his own
error.
4. After
1991, lessee can require lessor to sign a division order, but set a form lessee must
use. Can’t sneak provisions in ratifying
other leases or those
will be void.
E.
The Market Value Problem:
1. This
occurs where one is determining the market price at the well. In
a. transportation cost if
reasonable
b. processing costs if reasonable
c. costs of running the processing plant if
reasonable
2. How to
determine market value: generally done
by reference to the geographic area in which similar gas is
sold. So, look at comparable sales.
F. Royalty on take or pay clauses: A gas contract on take-or-pay clause
obligates a purchaser to pay for a percentage of the gas that the producer can
produce, whether or not the purchaser actually takes it. Payments by the purchaser to the lessee.
1. Typical lease states “buyer will take, or pay
if not taken, $__ mcf/day.” Buyer must pay for contract volume and
contract price.
a. Majority Rule: lessors cannot secure any share of take or
pay payments made to their lessees because royalty not due until gas actually
produced.
b. take or pay payments are based on gas not
produced; royalties are due only on gas that is PRODUCED. Therefore, lessors do not share in the take or pay payments. Diamond
Shamrock v. Hodel.
c. If a settlement of a take or pay clause were
to effect and change the royalty, the lessor may have a better claim, but if
the reasonably prudent operator were to make the settlement, probably no claim.
i. Minority
View: Frey v. Amoco Production: “look
not at the parties’ intent to provide expressly for take-or-pay payments, but
rather at the parties general intent in entering an oil and gas
lease...reflecting the mutuality of objectives and sharing of benefits inherent
in the lessee-lessor relationship.” (
G. Proceeds Clause - “on gas, 1/8 of
market value; provided, that if lessee sells the gas [at the well, on the
lease, or in the field] then the royalty shall be 1/8 of the amount the lessee receives from the sale.” The best clause would say whether before or
after processing. If gas is not sold,
then no royalty is required.
1.
Majority Rule (TX, LA) - absent something in the lease to the contrary,
royalty means 1/8 market value at well on day produced. This means royalty goes up with
the market price.
2. Minority - royalty paid only upon market
value provided in the contract if said value is prudent and in good faith.
VI. IMPLIED COVENANTS IN OIL AND GAS LEASES - violation of an implied covenant will not
automatically terminate the lease.
A.
The Covenants: (all held to the reasonable prudent operator standard)
1. To Develop
2. To Protect
3. To Manage
B. In
1. Implications to the “In fact” designation
a. Statute Of Limitations for breach of contract
applies - statute begins to run
when should have realized it, not when actually realized it.
b. the lessee remains liable even after
assignment of the lease
c. allows the parties to contract around them if
they want to . No punitive damages in
C. The
Standard of Performance:
1. THE REASONABLY PRUDENT OPERATOR: the lessor has the burden of proving that the lessee has failed, as to
a particular implied covenant,
to do what a reasonably prudent lessee would and should have done in similar circumstance. Usually means that the lessor needs to show
that the action would have been profitable to the lessee.
a. The drilling expenses are included in
measuring profitability under implied covenants.
D. The
Implied Covenant to Protect: also known as the covenant to protect
against drainage. Requires that lessee
act as a reasonably prudent operator to protect the leased premises against
drainage. This is an exception to the
general rule that the lessee has no obligation to drill during the primary
term. Payment of delay rental payments
is no bar to a claim under this covenant.
1.
Elements:
a. substantial damage
b. reasonable prudent operator would drill a
well to protect the premises against drainage. - the well would have been
profitable.
c. damages - measured by royalty the lessor
would have obtained had the offset well been drilled with interest to date
of trial. Need to
prove with reasonable certainty the quantity of production that the
offset well would have achieved.
d. lessor must give lessee notice of demand and
time to remedy.
e. applies to field wide drainage. There is a duty to protect against field wide migration subject to the RPO
standard.
2. Remedy:
a.
In
b. If
legal remedy insufficient,
E. The
Implied Covenant to Develop:
Once oil and gas are found on the premises, the courts have recognized
an obligation to continue to develop the premises reasonably. An economically motivated prudent operator
will fully develop resources under his control within a reasonable period of
time. Lessee must proceed diligently
-time is an important factor. If paying
delay rental payments, don’t have to worry about this.
1. Elements:
a. there is a probability that additional wells
drilled would return the costs of
drilling, completing, and operating, plus a reasonable profit.
i. Can refer to geological testimony as to
probable sites, technological information from nearby wells to establish
probability and productive capacity, and financial statistics of production
prices.
b. the lessee has acted imprudently in failing
to drill such wells
i. Successful development of nearby property,
passage of an extended period of time without development, and willingness of
other operators to drill may suggest a breach.
c. damages (equal to amount of royalty lost
because of the lessee’s failure to drill developmental wells) are subject to a
4 year statute of limitations. This can
be difficult to prove.
d. Lessee needs to be informed of his breach and
should be given opportunity to redeem himself, by commencing further
development within a reasonable time.
Notice and demand are only required when seeking termination of the
lease.
e. If lease contains a clause pertaining to
development or limiting the scope of this covenant - lessee not required to
drill more than X wells per X acres -
will be upheld by the court and this covenant will not apply unless court views
the number of well established in the lease to be a minimum number of wells.
2. Remedy:
a. Cancellation:
Common remedy in
b. Conditional Cancellation: lessee is ordered to commence additional
development within a stated period or suffer cancellation of the lease.
c.
Damages: may be awarded in addition to
cancellation or solo.
3. In large tracts, it may not be a good idea to
rely on this covenant, instead have a continuous
drilling clause in the lease - if you develop the land, you have an
obligation to drill another well in so many days after the first well is drilled. So you are required to continuous drill the
premises until you reach a certain density specified in the lease. Failure to drill to this density will
obligate the lessee to release the undeveloped tracts back to the lessor.
F. The
Implied Covenant to Manage: Includes
the duty to market, operate with care, apply for exemptions, variance, permits,
manage property in a safe condition (diligent and proper operation), etc. Could include a duty to Farm Out.
1.
Elements of covenant to market:
a. requires the lessee to market production from
the leased premises within a reasonable period to time (more time for gas) and at the best available price.
i.
ii. Lessee has a good faith duty to obtain the
highest price for the product. Amoco v.
iii. favored notion clause - clause
allowing lessor to get high revenues from purchaser for production as the
market goes up. Courts no longer like
this. To be sure getting same as everyone
else in the area.
iv. Notice to the lessee is essential where the
lessor asks the court to exercise equitable powers to cancel the lease. May also be required by the contract
principle of cooperation whenever the basis for the claim of breach of the implied
covenant is the lessee’s failure to market the product within a reasonable
period of time; presumably, the lessee can mitigate the lessor’s damages by
acting promptly after such notice.
v. Lessor cannot be held to have waived this
covenant unless he knowingly ratified the terms of a gas contract.
vi. The purpose of the shut-in royalty clause is
protect the lessee against loss of the lease for failure of production where
marketing isn’t possible or advisable, not to relieve the lessee of the duty to
market.
b. Must show the lessee acted imprudently
i. Amoco v. First Baptist: proved that other owners had contracted
to sell their gas on substantially better terms than those obtained by
Amoco. Amoco had obtained a substantial
improvement in the price that it received under the 1969 contract by trading
off the interests of the lessors.
c.
Remedies:
i. Failure to Market within a reasonable time
a.
cancellation - once lessee has gone to the risk and expenditure of
developing a well on leased premises, the courts are reticent to find that the
lessee’s rights have terminated.
1. If claim made during primary term, plaintiff
will ask court to exercise
equitable powers and terminate the lease
2. If claim made after primary term expired,
lessor will say that
lease has terminated on its own terms because of lessee’s failure to
secure production in paying quantities.
b. Damages - As a general rule, this is the most
likely remedy.
ii. Failure to Market at a Reasonable price
a.
Damages - if the breach proved is a sale by the lessee at a less than fair price.
2.
Elements of Implied Covenant of
Diligent and Proper Operation
a. The reasonably prudent operator is
competent and will use enhanced recovery techniques where they will be
profitable. It will seek to protect its interests and its lessor’s interests by
seeking voluntary or compulsory pooling or unitization or appropriate
administrative action.
b.
Four types of objections: lessee has
damaged the property by negligence or incompetence, lessee has damaged the
lessor by premature abandonment of a well capable of producing in paying
quantities, lessee has failed to use advanced production techniques, and lessee
has failed to protect the lessor by failing to seek favorable regulatory
action.
c. Because it is so broad, this is
the category most likely to be used
the court in the future to remedy problems even though they do not clearly
within the categories noted.
d. Remedy is most likely damages. Court could issue and alternative decree ( TX
won’t) - clean up or lose the lease. Damages would be the amount of royalty
received from the well if the well had produced as suppose to.
e. If lessee fails to settle with
buyer and buyer files bankruptcy, court
might allow lessor to recover for breach of duty to manage. Never
been litigated, though. RPO might be
applicable.
VII. DEVELOPMENT BY CONCURRENT OWNERS - A tenancy in common of all the land or just the
minerals. Conveying 1/2 mineral interest creates a tenancy in common.
A. Majority Rule:
1. One tenant can enter and drill without the
consent of the other co-tenants
- Prairie Oil and Gas v. Allen.
a. Each
co-tenant has the right to possess the whole.
2. The
producing co-tenant must account to his nonconsenting co-tenant for their share of the profits. Producer gets all of his investment back before he has to start
paying the nonconsentor ( a portion of the net profit {gross revenue - capital and operating expenses}) - up to
500% of his investment.
3. The cost of a dry hole is completely born by
the entering co-tenant who
chose to drill without permission.
4. If the cotenant entered to prevent drainage
and hit a dry hole:
a. will still would probably eat the costs
alone, but there has not been a
decision on this
b. might argue that you were making a good faith
effort to prevent drainage.
c. now if you hit a producer while
preventing drainage you would clearly
have to split your profits less your costs.
5. If your
first well was a dry hole and then you drilled a second well that was a producer:
a. the courts are split. Some will allow you to charge the dry hole costs to the
nonparticipant if you obtained information from the dry hole that allowed you to locate
and drill the producer.
6. Delay Rental Clause
a. If the delay rental clause
says “if no well be drilled”, then
drilling on the participating
cotenants land will hold the lease on the nonparticipating
owner’s land as well. However,
production on the participant’s land will
not carry over the nonparticipant’s lease if the habbendum clause says “production by the
lessee.” - Earp v. Mid-Continent.
B. Minority Rule: A contenat can be enjoined by a nonconsenting
cotenant from drilling on the
property without permission.
C. Partition:
the court ordered division of jointly owned land into separately owned tracts. Each cotenant is allocated specific portions
of acreage in proportion to his
undivided % ownership in the mineral estate.
Used when a significant
portion of ownership interest is made up of nonparticipating cotenant.
Not worth consentor’s time to spend $ and then have to share.
1. The
right of mineral interest owners or landowners to partition is absolute. A cotenant can thus demand partition (
2. If can’t be partitioned fairly in kind (due
to different terrain), court will partition
by sale. Can partition mineral interest
different from the surface.
3. An
agreement to partition is enforceable for a reasonable time and cannot violate the rule
against perpetuities.
4. Types
of partition: normal property division,
by sale - sale land and divide
proceeds, checkerboard - give alt. owners alt. squares, and auction.
D. Life Tenant and Remaindermen
1. When
both the life tenant and remainderman hold a legal interest, then the consent of both is necessary to
execute a lease.
a. Life tenant has the right to
exclusive possession for her lifetime and can
only exclude others from drilling. - Welborn
v. Tidewater.
2. Division of proceeds where a life tenant and
remainderman grant an oil and
gas lease without agreeing specifically upon the division of the proceeds:
a. funds are generally allocated
on the basis of the way the funds are classified
- Income or principal. If it is income,
it is paid to the life estate,
if corpus it goes to the remainderman.
Royalties are corpus. Life tenant has the right
to use the royalties - custody and is liable to the remaindermen for misuse.
i. Unless something to the contrary in the
lease, lessee is usually off
the hook if he pays the royalty to the life tenant.
b. life tenant generally receives
delay rentals. Bonus and royalty are invested as corpus, with
interest from the investment paid to the life tenant,
and the corpus distributed to the remaindermen upon the life tenant’s death. No Tex. Supreme Court cases on this; just
income tax cases. Get a division order to be safe.
i. To be safe, you might want to pay 1/2 of the
delay rentals to the life
tenant and divide the other 1/2 between the remaindermen.
3. A valid
lease can be obtained by: both agree,
both sign separate leases
to same mineral lease, or life tenant signs and remainderman ratifies.
4. Open
Mine Doctrine/Rule: Where there
is an open mine on the property
when the life estate is created, the life tenant is entitled to all payments under the lease. Remaindermen get nothing until the life tenant dies.
a. When a lease has been executed
prior to the creation of a life estate,
the life estate is entitled to all payments under the lease (bonus, delay
rental, royalty, etc.).
b. For the doctrine to apply, the lease need not
have a producing well on
it at the time the life estate is created, just need an existing lease.
c. If an oil and gas lease in
force at the time of the creation of the life estate
expires and a new lease is executed after the creation of the life estate, the open mine doctrine
does not apply.
d. Provides a limited exception to
the general rule that a life tenant is liable
to the remaindermen for waste if he misuses the corpus of the estate.
5. Equitable
Interest (TRUST ACT): overrides the Open
Mine Theory. If the life tenancy and remainderman are
created by a trust in
a. Delay rentals are income to the life tenant.
b. 27.5% of all bonus, royalty, and production
payments, but not to exceed
50% of the net after deducting expenses are treated as corpus
and go to the remaindermen.
c. 72.5% treated as income and
goes to the life tenant. Also income (interest) from the 27.5%
will go to the life tenant. Treated like
rent.
d. Lessee can safely pay all
royalty to the life tenant and let the life tenant
worry about dividing between the remaindermen when OMD and Trusts do not apply.
e. In
6. Creditors:
a mortgagee can enjoin drilling if it jeopardizes the value of its security.
a. It is usually best to
subordinate even where sole owner and mineral owners
are not the same. Subornation - agrees
any foreclosure will junior
to the lease. Pay 1/2 delay rentals to
the bank.
b. Doctrine of marshaling
assets: When the drilling company gets
an order of
foreclosure, sale will first be subject to the oil and gas lease (protect lessee’s
interest). If the bank does not get
enough to pay it off,
the oil and gas lease will be sold.
c. Superior easements (H2O, sewer, etc.) must be
respected.
d. Oil and gas lien - anyone furnishing
equipment, supplies, or labor to
well has type of mechanics lien.
7. Term Interest: shut-in payments under an Oil and gas lease
do not act as production for the term mineral interest. Must place the shut-in royalty clause in the
royalty deed or have it say is in effect as long as the oil and gas lease is in effect.
a. Unless defined in deed, production means
actual production.
b. this is an area of debate and some courts
differ on what production is
under a term lease.
VIII. Executive Right - the power to lease minerals. The power to bind the property by lease.
A. An executive right is an interest in land and
not a power. The executive right is a property right in
1. Since in
2. In a conveyance to another party, if you do
not specifically reserve the executive
right, it will be conveyed.
B. Duty of the Executive Right Owner: Utmost Good Faith:
1. the care an ordinary prudent person would
exercise without speculation - the duty to act
as if dealing in your own affairs.
2. duty of loyalty
3. duty to share appropriately - do not take
benefit solely for yourself.
4. duty to avoid self dealing - can’t buy some
of the trust property or sell your
property to the trust.
5. does not require subordination - where
trustee must subordinate his personal
interest to that of the trust estate.
C. Power of Attorney - will be strictly
construed, so if does not say power to execute
an oil and gas lease, you can’t do.
1. dies when assignee dies unless say so
otherwise.
D. Relinquishment Act: in certain cases up to 1939, the
state is the lessor and the executive
right owner actually owes a fiduciary duty to the state, and must avoid conflict of interest, use utmost good faith, refrain from
self dealing and
subordination. Only covered Oil and gas.
1. Patent prior to
2. Patent after
3. After 1908, all lands labeled as mineral
bearing and state reserved mineral
interest.
4. After 1931, the state reserved a
nonparticipating royalty 1/8 of 8/8.
5.
The Relinquishment Act appointed the surface owner as agent of state for purpose of issuing
leases - must use state form and file with Bureau of Land Management. As compensation, surface owner gets 1/2
(1/16) of oil or gas or 40% of
the hard mineral bonuses, delay rentals, and royalties. Surface
owner can sell his royalty (1/16) under this lease, but not right to royalty under future
leases. Surface owner has same duties as
an executive
owner - utmost good faith, and fair
apportionment, but must also
subordinate own interest to that of state.
E. The second Relinquishment Act:
IX. INTERPRETIVE PROBLEMS
A. Rules of Construction (provide
objective inferences of what the parties’ intent
might reasonable have been):
1. Horton’s Rule - four corners approach
2. If ambiguous, construe against interests of
the party who prepared it, who
was in position to have intent clear.
3. Typed or handwritten provision will prevail
over printed provisions because
they are more likely to express the intent of the parties.
4. General words following the specific will be
interpreted by the rule of ejusdem
genres to refer to terms of the same kind or class as the specific term.
5. As a last resort, courts examine the
attendant circumstances of the conveyance. They may consider parol evidence (oral) as well as the performance of the parties before the
dispute and extrinsic evidence in the
form of letters, memoranda, or records bearing upon the negotiations that led to the ambiguous
conveyance. BUT rarely done.
B. Other Minerals:
1. Ejusdem genres rule - includes things similar
to the group mentioned.
2.
a. Surface Destruction Test: severance prior to
1. Courts generally held substances within 250
feet of the surface were
near the surface. Now can go down to 300
feet.
b. Ordinary and Natural Meaning Test: severance after
1. building stone
2. limestone
3. caliche
4. surface shale
5. water
6. sand
7. gravel
8. near surface lignite - to 250 ft.
9. near surface iron ore - to 250 ft.
10. near surface coal - to 250 ft.
11. if it is not on this list, it is presumed to
be a mineral.
c. The
d. Royalty interests as to which minerals are
included is subject to these
same tests.
3. Community knowledge test: a substance is considered to be a mineral if it was
regarded a such by the community in which the instrument
was given at the time of the conveyance.
4. Exceptional characteristics test: a substance is considered to be a mineral if it was regarded as
such by the community in which the instrument
was given at the time of the conveyance.
5. Rule of practical construction: the actions of the parties contemporaneous
with or subsequent to the conveyance are considered to establish the intention of the parties. If the negotiations concerned only oil and gas rights, only
substances produced in conjunction with oil and gas are likely to be minerals.
6. Methane forms in coal beds and is
poisonous. Conveyance of gas only includes gas
released and not gas remaining inside.
B. The Mineral/Royalty Distinction:
1.
A mineral interest possesses the right to develop or to lease, and to keep the proceeds of
leasing (bonus and delay royalties). A
royalty interest
lacks those rights, but has a right to a share of production free of the costs of production.
2. Where there is no production, a mineral
interest is preferable because it
gives the right to lease and receive bonus and delay rentals. Once production
has begun, a royalty interest is preferable because it is cost free.
3. Courts are likely to hold that terms such as
“minerals”, “mineral interest,” “oil and gas rights,” “oil and gas in and under,” “in and under and that may be produced
from” create mineral interests, unless other provisions
of the instrument conflict with that conclusion. OR if it is called a mineral interest, the
interest is cost bearing and profit sharing, or the Interest has the right to lease and share in
lease benefits; i.e., bonus, delay
rentals, and shut-in royalties.
4. Use of the term “royalty” is generally
considered to indicate an intent to create
a royalty interest. OR the grant or
reservation is of oil and gas “produced
and saved” or “produced, saved, and marketed,” or other language that describes oil and gas
after it has been produced; the interest
is not cost bearing and profit sharing, but a percentage of gross production; or the
interest has not right to lease or share in lease benefits.
5. When drafting a deed, it is best to label the
interest and the describe the
rights the interest is entitled to.
C. Fractional Interest Problems - Described vs.
Conveyed:
1. O conveys land without warranty and reserves
1/4 of any lease royalty
on the minerals where O owned 1/2 of the mineral interest.
a.
The In sequence Rule: A deed that does
not specifically limit the quantity
conveyed, will be interpreted to describe 100% of the property described, both
surface and mineral. In other words,
court interprets the
language describing what A conveys before it examines the language
of O’s reservation.
b. The Literal Interpretation Rule: Words of conveyances are given their literal
meaning; the drafter of a formal instrument of conveyance is deemed to mean
exactly what he or she says.
1. conveying “1/2 of the minerals out of the 1/2
interest owned by them”
meant 1/2 from the 1/2
c. O cannot reserve more than he had to give,
which suggests that he only
reserved 1/4 of the royalty paid on the 1/2 of the minerals he conveyed. There is a double fraction problem here.
2. Since the
a. If the deed reserves a fraction of the
minerals under the land CONVEYED
it reserves a fraction of the mineral interest owned by the grantor at the time
of the conveyance. Where a deed reserves
a fraction
of the minerals under the LAND DESCRIBED, reserves a fraction of the minerals under the
entire tract, regardless of the size of the
interest actually conveyed. - Averyt v.
Grande, Inc.
i. X owns 1/2 mineral interest. X grants to Y an undivided 1/2 interest
in 240 acres that he has the interest in.
X reserves an undivided
1/8 of the usual 1/8 royalty interest from the ABOVE DESCRIBED LAND. X is
held to be entitled to 1/8 of 1/8 royalty or 1/64.
ii. If above conveyance had read that X reserved
an undivided 1/8 of
the usual 1/8 royalty from the ABOVE CONVEYED land, X would have reserved
1/2 of 1/8 or 1/16.
3. To avoid ambiguity, lease should say “1/4 of
100% of any lease royalty”
or “1/4 of any lease royalty payable to the fraction of the mineral interest that I hereby
convey.”
D. Overconveyance: this occurs where the total of the fractions
reserved and conveyed is greater than
100%.
1.
Duhig rule: court generally deals with the problem of
overconveyance by
warranty deed by deducting the overconveyance from the grantor’s interest, to the
extent that is possible. Grantor and a
third party each owned 1/2 mineral interest. Grantor conveyed the land to a grantee reserving 1/2 of
the minerals. Grantee gets 1/2 and the
third party gets 1/2
leaving the grantor with nothing, because all he had was 1/2. To protect
himself, deed should have said reserving 1/2 of the minerals subject to the
third party’s 1/2 mineral interest. (TX, CO, OK, NM, WY, LA, MS.
AL, AR). Also triggers the doctrine of
acquired title - estopped from saying
still own minerals after you convey them to someone.
a. Can be changed by reference to prior deeds or
only conveying surface
rights or reserving all minerals.
b. WHERE FULL EFFECT CANNOT BE GIVEN BOTH TO GRANTED
INTEREST AND TO THE RESERVED INTEREST, PRIORITY
WILL BE GIVEN TO THE GRANTED INTEREST (RATHER THAN TO THE RESERVED INTEREST)
UNTIL FULL EFFECT
IS GIVEN TO THE GRANTED INTEREST.
1.
Example: A conveys Blackacre to B
reserving a 1/2 mineral interest. B conveys Blackacre to C reserving a 1/4
mineral interest
(which granted 3/4 to C). A gets 1/2, B
gets 0 (because he did not make his reservation subject
to A’s 1/2), and C gets 1/2.
c. In
d. Does not apply to oil and gas leases. Benge: owned 3/4 (6/8) and conveyed land reserving 3/8. He granted 5/8 only reserving 3/8, but he only had 6/8. In essence, he reserved 1/8. BUT court said
that oil and gas leases are a special conveyance. The lessor customarily
grants a lease of the whole mineral interest although the lessor owns only a fraction, leaving the lessee to
reduce payments
proportionately by application of the lesser interest clause; i.e., the
parties to such transaction do not intend that estoppel
apply. Oil and gas leases are commonly
prepared by lessee
and not lessor, so there is no reason to interpret an ambiguity against the lessor.
1. as long as the lease is in force, he owns
3/8. If he enters and
drills himself (without a lease), he gets 5/8 net profit, not gross.
e. Quitclaim deeds are usually not subject to Duhig either because a quitclaim deed is a conveyance of
only what you own anyway without
warranties.
2. To avoid the problem of Overconveyance,
include one of the following:
a. “reserved to O 1/4 of the mineral interest in
addition to the 1/4 mineral
interest previously reserved to X” or “excepting all previously reserved
interests.”
b.
“reserving to O an undivided 1/4 mineral interest, it being the intention of the
parties that A shall have an undivided 1/4 interest and that O shall retain an undivided 1/4 mineral interest, in
addition to the 1/4 mineral
interest previously reserved to X.?
c. “O grants A all the surface rights and 1/4 of
all the minerals in and under
and that may be produced from” Blackacre.
d. Mineral Acres v. Royalty Acres
1.
Mineral Acres: the full mineral interest under one acre of
land. Conveying
in terms of mineral acres is a useful tool when the intention of the parties
is to establish a minimum limitation on the grant
or reservation; i.e., the grant of an “undivided 25 mineral acres
in Blackacre” is definite and certain.
a. Problems:
i. a grant of mineral acres is not necessarily
the equivalent of
a fractional interest conveyance. If
parties think Blackacre
contains a total of 100 acres, the parties may intend that a
grant of “25 mineral acres in and under Blackacre”
be the equivalent of an undivided 1/4 mineral interest. If Blackacre is either more or less than 100
acres, 25 mineral acres will either be less or
more than an undivided
1/4 interest.
ii. If one mixes references to mineral acres and
undivided fractional
interests in a grant or reservation of an interest in property that
subsequently turns out to be either larger or smaller than
anticipated, the stage is set for litigation.
2. Royalty Acres: the full lease royalty (whatever percentage
may be
specified in present or future leases) under one acre of land.
a.
b. Some courts define it as the full production
from one acre.
c. Avoid using this term unless it is defined
clearly.
E.
Conveyances of Leased Property:
1. “Subject to Clause”: states that the deed is subject to
existing or future
oil and gas leases. “This deed subject to an oil and gas lease dated ____, to Wildcat
and covers and includes 1/2 of the rents and royalties
payable there under. And if said lease
ever terminates, then grantee
shall be entitled to receive 1/2 of rents and royalties under future leases.” Is a transfer of unaccrued lease payments.
a. designed to protect the grantor against
claims for breach of warranty
because of the outstanding lease, and also avoids the Duhig problem. The clause is intended to make clear that the
grantee is to receive
an interest in unaccrued rentals and royalties under the lease.
b. Because shut-ins are either rent or royalty,
they pass here. Acceptance of shut-in
royalties by grantee ought to prevent cancellation.
c.
Problems occur when the interest referred to in the clause are inconsistent with
those of the granting clause.
1.
The Hoffman case and the Double
Grant Theory: O owns 320 acres and conveys an
oil and gas lease to B. O conveys to X
1/2 mineral
interest in 90 acres, subject to an oil and gas lease to B, and including
1/2 of all royalties and rentals to be paid under said lease.
B drills a well on the 320 acres, but not the 90.
a.
The basic argument was that the deed contained 2 grants: one of a
reversionary right to the mineral interest in the 90 acres and another of 1/2 of the
benefits under the existing lease from
the whole 320.
b.
The first grant conveyed to X 1/2 mineral interest in the 90 acres. The second grant conveyed to X half of all
royalties under
the lease on the 320 acres. Therefore, X
will receive 1/2 of
all royalties from the well that B drilled.
i.
Should have said “1/2 of all royalties and rentals to be paid
under the said lease in so far as it applies to said 90 acres.”
a.
subject to clause should say 1/2 in the blank and not 1/16
in both blanks or can say “receive same fraction” in the second blank.
c.
Differing numbers in the subject to clause will be OK as long as the court
allows the subject to clause to override the granting clause.
d.
Subject to clause should be avoided as a place to make a reservation or can end up
with a double grant. If the grantor wishes to reserve or
convey an interest in an outstanding lease different
from the mineral interest reserved or conveyed, that should be specifically and carefully drafted in a
separate reservation. If above isn’t possible, include a Hoffman
provision after cover and
includes language: “in so far as it
covers the above
described land in the granting clause,” and that makes it clear that nay royalties
and rentals referred to cover only those set
out in the granting clause.
2. Can convey one fraction of royalty and one
fraction of minerals
a. Granting clause says conveys 1/32 royalty
interest (fixed fraction
that will not fluctuate). Subject to
clause says 1/4 of any
and all royalties (will fluctuate b/c says of).
The future lease clause says 1/4 of any and
all royalties. The original lease
expires. Five new leases say conveys 1/6
(not 1/8) royalty. Plaintiff’s royalty floats at 1/4 of 1/6 or
1/24, not what the granting clause says because
it is conflict. - Luckel v. White
b. Granting clause says 1/16 of minerals
(fluctuates). Subject to
clause says 1/2 of present and future revenues.
The court applies
the granting clause giving 1/16 of 1/8.
Supreme court says gets 1/2 of royalties - apply
double grant theory - no conflict
- Snow v. Jupiter
c.
Granting 1/96 of minerals.
Present lease clause conveys 1/12. No future lease clause. Where no future lease clause, granting clause
trumps. Based upon special language,
clear only one estate
in land intended to be conveyed and won’t be changed
by separate conveyance. Present lease
clause f 1/12
gross production applies to future leases.
This is a special case.
-
2. The
Non-apportionment Rule: lease
royalties are not apportioned among the owners of subdivided property. Instead, the owner of the tract where the
well that produces the oil and gas is located is entitled to all royalties due
under the lease unless lease contains a subject to clause. Usually happens when an individual purchases
a tract of land separated by the owner who has the lease, but purchasers tract
does not have a well.- Japhet v. McRae
a.
Where the property subject to an oil and gas lease is subdivided by the lessor or her successors,
the issue arises as to how subsequent payments
under the lease are to be shared by the various property owners. Payments of delay rentals will be apportioned
among the owners
of the subdivided property proportionate to their share of the mineral
interest.
1.
That the subdivided tracts are subject to a single oil and gas lease does not
change the result because there is nothing in typical
leases inconsistent with the rule of capture.
2. Royalties are not payments that issue
equally for each and every
part of the land; they are a right to production if and when it occurs. The rule of capture dictated that production
belongs to the owners of the subdivided part upon which
the producing well is located.
b. The non-apportionment rule may be changed by
an ENTIRETY CLAUSE: This provides that if the leased premises are
ever owned severally
or in separate tracts, all royalties accruing under the lease shall be treated
as an entirety and shall be divided among and paid to the separate owners in the proportion
that the acreage owned by each bears
to the entire leased acreage.
1. Is a form of pooling
2. It seeks to treat separately owned tracts as
a single lease. As far as
advantages and disadvantages to the lessor, it all depends on your
royalty interest. It also relieves
lessee of obligation to offset within leased
property. Increases the take home pay. Gets around
spacing.
a. IF THE LEASED PREMISES SHALL {NOW OR} HEREAFTER
BE OWNED SEVERALLY OR IN SEPARATE TRACTS,
THE PREMISES NEVERTHELESS SHALL BE DEVELOPED AND OPERATED AS ONE
LEASE AND ALL ROYALTIES
ACCRUING HEREUNDER SHALL BE TREATED AS
AN ENTIRETY AND SHALL BE DIVIDED AMONG AND PAID TO SUCH SEPARATE OWNERS IN THE
PROPORTION THAT
THE ACREAGE OWNED BY EACH SUCH SEPARATE OWNER
BEARS TO THE ENTIRE LEASED ACREAGE.
3. Today, entirety clauses are not favored.
c. The non-apportionment rule can also be
avoided by modifying the agreement
to call for apportionment. Parties can
contract around it.
d. A minority of courts treat royalty like rent
and hold that it is producible
equally for all parts of the subdivided land.
It is apportioned
accordingly - MS, PA, CA, and
e. In
3. Top Leases:
an oil and gas lease covering property already subject to an oil
and gas lease; it sits on top of an existing lease. It is a partial alienation of the possibility
of reverter retained by the mineral interest owner under the original or
“bottom” lease.
a.
Rule Against Perpetuities: a contingent
future interest is void unless
it vests or is destroyed within 21 years of some life in being at its creation.
i. A top lease will be void if it violates the
rule against perpetuities.
a. “This lease shall be effective from and after
the termination of
the current lease.” - is void in
1. Where a lease has expired and the lessor
ratifies it by conveying
a portion of the royalty subject to that lease, court says that you
can’t ratify something that is void.
Reviver will not help if the
problem is perpetuities. - Hamman.
2.
3. Court has the power to change the estate if
it can Interpret
the deed in any way without violating the rule against
perpetuities.
ii.
If the interest conveyed in a top lease is considered a possibility of reverter, it
should not be subject to the rule; the possibility of reverter is a vested interest.
iii. To avoid problems, it should state that it
becomes effective on a certain
date within the perpetuities period or immediately.
b. Doctrine of obstruction: If a top lease does not refer to the existence
of the prior existing lease, then the title of the bottom lessee is clouded, whether
or not the top lease is recorded. It
suspends the running
of time under the bottom lease for the duration of the obstruction or extends the
primary term of the bottom lease for a reasonable
period of time after its removal.
i. Should specifically state that top lease
subordinate to the bottom.
ii. Most drafters include a specific undertaking
by the top lessor (who
is also the lessor of the bottom lease) not to extend the bottom
lease or to grant a new lease to the bottom lessee.
X. ESSENTIAL CLAUSES IN A MODERN OIL AND GAS
LEASE
A. Proportionate Reduction Clause: Also called the lesser interest
clause. A
lease clause that permits the lessee to reduce payment (royalty and delay rentals) under the lease proportionately
if the lessor has less than 100% of the
mineral interest. This is a defensive
clause.
1. Intended to be used on a lease which on its
face conveys the full fee simple. Prevents the lessee against the possibility
of being required to pay
twice for the same mineral interest.
a. IT IS AGREED THAT IF LESSOR OWNS AN INTEREST
IN THE OIL,
GAS, OR OTHER HYDROCARBONS IN OR UNDER SAID LAND LESS THAN THE ENTIRE FEE SIMPLE ESTATE, THEN THE ROYALTIES AND RENTALS TO BE PAID LESSOR
SHALL BE REDUCED
PROPORTIONATELY.
2. Covers fractional and not geographic
discrepancies.
3. Describe the full fee simple in the
description, but use a cut down clause
to cut down to portion actually owned.
“1/2 interest in above described
land.”
4.
Works together with warranty clause.
Warranty clause allows lessee to
sue the lessor for breach of warranty of title (convey more than they own). Lesser interest clause authorized the lessee
to proportionately reduce
future lease benefits to the extend that title has failed.
5.
If you describe the land as a 1/2 interest in the whole (which is all grantor owned) in the description, the proportionate reduction
(cut down) clause does not
apply. It depends on you not owning what
you describe. - Texas Co. v. Park.
B. Mother
Hubbard Clause: All inclusive
clause designed for oil and gas leases.
Does not cover deeds or even mineral deeds. A lease clause to protect the lessee against
errors in the description of property by providing that the lease covers all
the land owned by the lessor in the area.
Sometimes called a “cover all” clause.
Sometimes combined with an after-acquired
title clause. *always need this*
1.
To pick up relatively narrow strips which were not known as separate tracts in the community at the
time. If landowner also owns adjacent piece of land which has a
lease on it (base lease) and leases the second tract to another lessee, all inclusive clause does
not extend to the adjacent
land because they were known as separate tracts.
a.
THIS LEASE ALSO COVERS AND INCLUDES ANY AND ALL LANDS OWNED OR CLAIMED BY THE LESSOR
ADJACENT OR CONTIGUOUS
TO THE LAND DESCRIBED HEREINABOVE, WHETHER
THE SAME BE IN SAID SURVEY OR SURVEYS OR IN ADJACENT
SURVEYS, ALTHOUGH NOT INCLUDED WITHIN THE BOUNDARIES
OF THE LAND DESCRIBED ABOVE.
2.
Some courts have limited the scope of such clauses to only cover unknown strips at the time
of conveyance, this prevents situations where an
uncareful lessor could end up leasing land he had not intent to lease but for the mother hubbard clause.
a. Jones: lease conveyed 100 undivided acres, but
tract described did
not contain 100 acres. However, if you
added the second tract to the
first they totaled 100 acres. Court said
can’t use all inclusive clause
to remedy the error. Must file under
contract law for mistake.
3.
Another reason you have this clause is because of adverse possession. Here a title buster could come in and lease
the land from underneath
the oil co. and then sell it back to them at a much higher price, or the title
buster can commence to drain the lease.
XI. INTERFERENCE WITH INTEREST IN OIL AND GAS
A. TRESPASS:
1. One who wrongfully enters and possesses
another’s mineral interest will
be liable to the rightful owner as a trespasser.
2.
Ordinary trespass: an example is
where the primary term has run and the
lease has expired, yet the lessee has not left.
This is an ordinary trespass.
3. Intentional slant well drilling can be a
trespass, or negligent slant well drilling
can also be a trespass.
B. GEOPHYSICAL TRESPASS: damage to lease value
1.
Merely sending shock wave alone onto another’s land while conducting
geophysical on your own land is not a trespass.- Kennedy v. General
Geophysical. BUT not right to shoot
on someone else’s property without
permission.- Enron Oil and Gas v. Worth.
2.
Where the surface estate has been severed from the mineral estate, mineral owner, rather than surface
owner is the one with the right to conduct
geological and geophysical operations.
a. surface owner has no right to hold you up,
but you should consider getting
their permission before drilling starts.
However, there permissions
is not required.
3. Damages to lease value:
a.
Kishi case (has been limited
to its facts) - In
4.
Texas follows Kansas - let the mineral owner who has been trespassed
against and can’t prove damages, waive
the trespass and sue
in assumpsit - sue trespasser for what
he would have had to pay if
let on land with permission.
a. These damages are very difficult to prove, so
most plaintiffs use assumpsit.
C. Remedies for Trespass:
1. Damages - damages will depend on whether the
trespasser entered in good
faith or bad faith.
2.
Good Faith - defensive measure only.
Having an honest and reasonable belief in the superiority of one’s
title. A good faith trespasser is liable for the value of oil
produced from the land, but will be credited with
any costs incurred in production, provided those costs conferred a benefit on the owner’s mineral
interest.
a.
In
b.
If expenses exceed the production, some courts allow a good faith trespasser to have a lien
on future production.
c.
3. Bad Faith
a. willful
b. A bad faith trespasser will be liable for the
gross value of production
from the well without any deduction for costs.
His improvements
upon the property and all income belong to the property owner.
c. In
d. Unless the owner demands it, the trespasser
will not be permitted to
plug and abandon a well capable of commercial production; that would be
waste.
D.
ASSUMPSIT: One can waive a suit in
trespass and sue in assumpsit for the
value of the implied contract that should have been negotiated. The right to
shoot can be carved out of mineral estate and be leased out to individual for a limited time.
1.
If the trespass in the course of a geophysical operation, a suit in assumpsit will claim the
value of the geophysical permit that should have
been obtained.
2.
If the trespass is by actual drilling, a suit in assumpsit will claim
the lease
bonus that should have been paid.
E. SLANDER OF TITLE - usually brought where one party refuses to release a lease.
1. An owner may recover against a third party
who:
a.
maliciously - deliberate conduct without reasonable cause. It exists when
the slanderer lacks a bona fide belief in the validity of his own claim. In order to get punitives, must show ill or evil motive in disregard of one’s interest.
b. knowingly
c. asserts a false claim to land in question
(publication of a false claim)
- may be met by showing that the tree passer occupies the property.
d.
results in the loss of a specific sale to the real owner - In Texas, you can not recover unless you
prove this -Ellis.
2.
Malice - the deliberate conduct without reasonable causes. It exists when
the slanderer lacks a bona fide belief in the validity of his own claim.
a.
In order to get punitives, must show ill or evil motive in disregard of one’s interest.
F. EJECTMENT - owner who has suffered trespass
can eject the trespasser. Usually done when the trespasser discovers
oil or gas in commercial quantities,
particularly where oil and gas have been produced for a substantial period in large quantities.
G. CONVERSION - taking something that you don’t
own. Usually done when the trespasser discovers oil or gas
in commercial quantities, particularly
where oil and gas have been produced for a substantial period in large quantities.
H. DORMANT MINERAL ACTS (do not apply in
1.
Apply to profit a pendre states, where right is subject to loss by abandonment, not
ownership in place states.
2.
If there has been no activity on the deed record for a certain time, the
owner of the surface can
claim the minerals and if no one shows up for a statutory period of time, the mineral interest will be
extinguished. (a sort of abandonment theory)
3.
Activity includes: active
production, paying rent or royalties to delay production,
and paying of taxes.
4. Some raise a presumption of title
in the surface owner and other divest the
mineral owner of the minerals.
5.
Granting of a lease does not usually constitute an activity sufficient
to preserve.
XII. CONTRACTS AND TRANSFERS BY LESSEE
640 ACRE TRACT
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COMPANY A ASSIGNS 1/2
TO COMPANY B
A. Assignment and Transfer:
1.
Lessee generally has the right to transfer his interest. Most lease forms
contain language that specifically permits assignment. A lessee who
assigns the operating rights under a lease remains liable for future breaches. The lessee can protect himself by imposing a
specific obligation
upon the assignee to indemnify the lessee against such claims.
2.
Almost without exception, the provisions of an Oil and Gas lease have been held to be
covenants that run with the land.
Therefore, the Transferee
of the leasehold interest assumes all of the obligations imposed by the
original lease.
3.
Some jurisdictions have applied the assignment/ sublease distinction. Matters in La, but not TX
a.
sublease - takes on some, but no all of the lessor’s obligations. Where
assignor reserves something that can revert back to assignor. It
is basically a transfer of less than all of the leasehold interest.
i.
Examples: assignment for less
than the entire remaining term, reserving
a right to reenter, and reserving an overriding royalty interest.
b. assignment - a transfer of the entire
leasehold interest in all or any portion
of the property.
i. If classified as an assignment, lessor can
enforce covenants of the
lease that run with the land against the transferee as well as the his
lessee. The lessor will be in privity of
estate with the transferee and in privity of contract
with the lessee.
4. Protection of Non-Operating Interest By
Implied Covenants:
a.
Courts are divided as to whether a lessee who assigns the working interest retaining an
overriding royalty or other non-operating interest is entitled to the protection of implied
covenants.
i. More recent cases suggest that lessee is
protected.
b.
some courts have held that in a situation where a lessee has transferred his
operating rights in a lease and retained a non-operating
interest, the Transferee should not be a FIDUCIARY for the transferor.
i.
Transferee merely has an obligation to lessee and lessor to protect the
premises against drainage, to reasonably develop and explore once production is obtained, and
to perform as would a reasonable prudent operator under the
circumstances.
c.
Mere assignment of a lease with a reservation of an overriding royalty interest
without more, does not create a fiduciary relationship, which impinges upon the right of the assignee to
obtain from the owner
a top lease. Brannan v. Sohio.
i.
Override does not attach to top lease where base lease has already expired
(assignor-assignee relationship). Would
attach if deliberately
wait to drill (conspiracy) until the base lease expires. This
is an action in equity based on constructive trust to prevent fraud. Other relationships may allow it to attach,
it is a question of fact.
a.
Use this clause to be sure: “If
lease owner prior to expiration
of six months after base lease expires takes top lease, override shall attach”
(this covers new leases and renewals). OR you can (in the lease) obligate the
transferee to reassign
the lease before letting it expire.
ii.
Deferred drilling beyond overlapping period is ok, as long as not done in bad
faith - just to prevent assignor from collecting his due.
ii. When transferee allows the assigned lease to
expire and then releases
the premises from the lessor, this is called “washout”. One
who transfers operating rights but retains a non-operating interest is not protected by
implied covenant against washout. Brannan
v. Sohio and Sunac v. Parkes.
d.
Potash: Here the overriding royalty owner was
allowed to enforce implied
covenant against drainage, because no one else would protect her rights. Usually overriding royalty will wait for the
surface owner to bring
the suit.
i. Can insert a clause giving the overriding
royalty owner the right to
enforce. It should be placed in the
original lease with the driller.
5. Indivisibility of a Lease as to Express
Covenants:
a.
Habendum clause is indivisible unless the lease says otherwise. Production
from either portion of the subdivided lease satisfies the term clause of the
lease for the whole property. Not so in
i. To make habendum clause divisible, in
original deed, say “in event
of assignment as to less of lease premises, portion assigned and portion
retained shall be separate leases.
b.
ordinarily an assignee of a segregated portion of the leasehold holds his interest
subject to the performance or nonperformance of such express covenants.
c.
Performance of the covenant by any such assignee works to the benefit of all such
assignees and assignors. Nonperformance
works to the
detriment of them all.
d.
The provisions of an oil and gas lease have been held to be covenants
that run with the land.
6.
Implied covenants are divisible; however, the states are split. - this means failure of a covenant
on one tract does not interfere with your rights
on the other.
a. In
b. Implied - is not a matter of law, more of
fact. Did not bargain for the drainage problem and situation
where one assignee won’t act.
c. The general rule is that at least the implied
covenants to reasonably
develop and to explore further are divisible.
b. Letter Agreements: contracts used to encourage and support
drilling operations. Also called support agreements. The contributing party agrees to contribute money or property in exchange
for information. It is important that the parties clearly agree what test
information must be provided by the drilling
party and what conditions must be met for the contribution to be earned.
a. Dry Hole Agreement: The contributing party agrees to make a cash contribution if the drilling party
drills a dry hole. The drilling party generally agrees
to provide geological and drilling information whether or not the well is a dry hole.
i.
a common problem with letter agreements is failure to describe the interest to be transferred
with sufficient certainty to satisfy the Statute of Frauds.
ii. If you want a specific spot, you must
describe it in the letter.
iii. “If
you drill at a certain time to a certain depth and have furnished me with the
information described below and the well is dry, I will pay you $___. I will be allowed to observe operations at my
own risk and will be allowed to have core samples.
iv.
This is done when someone wants to know what is down there, but does not want to do it himself.
b.
Bottom Hole Letter: the
contributing party agrees to make cash contributions
to the drilling party in exchange for geological or drilling information, if a well is
drilled to a certain depth.
i.
“If you drill to a certain depth, I will pay you $__ regardless of whether the well is
dry or a producer.”
ii. Primary interest is getting information that
the well reveals (cuttings,
corings, samples, and logs - soundwave, neutron and electrical logs).
c.
Acreage Contribution Agreement: the
contributing party agrees to contribute
leases or interests in the area of the test well to the drilling party in exchange for
information, if a well is drilled to an agreed depth.
C. Farm Out Agreements: an agreement to assign an interest in
acreage in return for drilling or
testing operation on that acreage. The
farmor, the person or entity making
the assignment, may use the farmout agreement to maintain a lease by securing production close to the end of its
primary term, to comply with an implied
covenant to develop or offset, or to obtain an interest
in production without additional cost.
1.
The farmee may earn acreage not otherwise available or at a lower cost than otherwise possible, or
may be able to keep people and equipment
gainfully employed.
2.
Farmor maintains contingent liability for damages caused by farmee. If farmee
does not fulfill the agreement, lease returns to farmor. If farmee does
fulfill, then lease goes to farmee.
3.
If farmee promises to drill a well, then he may be liable if he fails to
perform the promise. One measure of damages is the cost of
drilling the promised
well.
4.
If drilling the test well is a
condition of earning rights under the farmout
agreement, the most common farmout agreement structure, then the farmee has no liability for failure
to drill. The farmee simply earns no right under the terms of the
farmout agreement. If lease provides an escape if unforeseen
conditions are encountered in drilling, farmee is forgiven.
5.
the well must be drilled to the full depth specified, all tests
specified must be completed, and
production sufficient to repay the costs of drilling ad return a reasonable profit must be obtained.
6.
If there is a covenant to drill, the measure of damages is so uncertain that a liquidated damages provision is
acceptable. The liquidated damages clause must
be reasonable or the court will strike it as a penalty.
D. Operating Agreements: a contract between co-tenants or
separate owners of oil and gas property being jointly operated. It sets out the parties’ agreement with respect to initial drilling,
further development, operations, and accounting. It pools the leases and fractional interest
of the parties for operating purposes.
1.
Usually does not cover more than 1000 acres, but can. First well is usually
specifically described as to its location, but it does not have to be.
2.
One party is designated as operator.
The custom is that the person owning
the largest acreage or person having worker in the are will be the operator.
a.
The operator on his own credit will purchase all supplies and materials that the
joint operation needs. The joint
operators are not liable
for this (creditors can’t go after the non-operators), but they do have to share these expenses. The operator pays and then bills the non-operators.
b.
Each party will also charge to the lease part of its longterm debt. All
this will vary a great deal and one party in such an agreement can be making a profit while
the other parties are loosing money.
c.
Operating agreements provide for a narrow scope of liability for the operator (gross negligence or
willful misconduct) and a limited basis for
removal.
i. When non-operators actively participate in
management or have the
right to do so, they may be jointly and severally liable with the operator as
mining partners, a partnership relationship implied at law. Otherwise, the relationship of the operator
and non-operators is
analogous to that of co-tenants, so that each is only liable for it own torts and
contracts.
a.
This is not a partnership -an agreement between two or more
owners to carry on business for a profit.
Here, each takes his
share in kind (multiple profits; a profit to each individual).
ii. Powers of the non-operators are generally
limited to approval or disapproval
of proposed operations - go-no-go decisions.
d.
The operator is under a duty to perform as a reasonably prudent operator or in a workman like
manner. There is not duty of good faith and fair dealing in an operating
agreement. The operator is NOT a fiduciary.
i.
You have a specific right to refuse.
You don’t’ have to frac just because
joint owners will benefit. Texstar North American. Operating
agreement has no implied covenant.
ii.
Performing as a RPO includes the obligation to share take or pay provisions
with the non-operator. The operator has
a duty to pursue a
take or pay claim. -
iii.
Where operator sells to his alter ego subsidiary at a ridiculous price, the profits
may be subject to claims by the joint operators. Atlantic
3.
It does not unitize the royalty interest; just the working
interest. Need a separate operating agreement to pool the royalty
interest.
a.
the working interest is pooled and all parties share in production according to their
fractional interests. Each will take
production in kind and sell
accordingly by themselves. There is no
revenue to the joint account.
4. Consent of all parties is generally required
to plug and abandon a well.
5. Operating agreements generally contain a
NON-CONSENT clause allowing
the other owners to go ahead and share the costs between each other, excluding the
non-consenter.
a.
This comes into play when the parties want to drill a second well and one party does not
want to go along. The consenting parties
take the dry hole
risk alone, but if they get a producer they do not have to account to the
non-consenter until they have recovered their costs plus an agreed % which is usually 500%.
6.
An operator will often obtain a lien on one of the non-operators who has filed for bankruptcy (personal and
real estate). Due to this, all parties record their operation agreements
in a short form summary with the clerk to
place BFPs on notice even if they have no actual notice.
a.
A lien against non-operator’s interest in proceeds from production is called a financing
statement which is filed with the Secretary of State. It covers personal property.
b. A mortgage is filed with the county clerk for
real estate liens.
c. MBank:
court held that operator’s lien was superior to the bank’s lien
because the court found that the bank was on inquiry notice of the operating
agreement. If claim title under a
document, you are presumed to know everything in the deed.
7.
AUTHORITY FOR EXPENDITURE (AFE):
only an estimate of costs to drill
and produce. Approval of the AFE is
commitment to pay one’s proportionate
share of all reasonable and necessary costs incurred until the objective is reached. You are agreeing to pay even if actual costs exceed those estimated in the
AFE.
a.
If you only want to pay your percentage of the AFE and nothing more, you
must make a counter-offer and the others must accept it. This is not achieved by just signing the AFE.
8.
Indemnification: has been allowed
in operating agreements, but in
a.
If operator guilty of gross negligence and owes damages to a third
party, the operator only pays his fractional share and joint operators pay their portion. Steine.
b.
This is prohibited in a contract relating to drilling of oil and gas
well except (TX, LA, NM): where indemnity is covered by insurance and the extent that it is. (NM does not have; and in a join operating agreement -
opeartor’s indemnity (even though operator negligent). TX
has both.
i. Texas Express negligence rule: must say I indemnify you even if caused in
whole or in part by you.
ii. Conspicuous rule: indemnity clause must be very conspicuous.
c.
Amoco Production: In
9.
Removal of Operator: accomplished
by a 2/3 vote by non-operating owners
by weight of ownership.
10.
Operator is subject to audit by all non-operators as to operating expenses.
11. Mining Partnership Implied at Law:
a. joint ownership
b. joint operation - don’t have this under joint
operating agreement because
one operator.
c. express or implied agreement to share profits
and losses.
d.
TX Uniform Partnership Act: joint
operating agreement does not per se
create a partnership.
XIII. POOLING
A. One well as a matter of right -
Rule 37: A small tract is a voluntary subdivision and will not receive one well
if: the tract was subdivided after oil and
gas was discovered in the near vicinity, the tract was subdivided by an oil and gas lease, and the small tract was
subdivided with the intent of circumventing
Rule 37.
1.
A rule 37 exception can be given to prevent confiscation or waste. Voluntary
subdivisions can receive waste exceptions, but not an exception based on
confiscation. Does not affect ownership
of real estate.
B.
History: because of this right to
drill one well, there has been a great deal of conflict between large and small
land owners. To add to the problems,
1. small landowners have no right to drill a
profitable well, they only have the right to drill.
2. allocation formulas that cause uncompensated
drainage are invalid.
a. The above allowables are not per se illegal.
b. Market
demand proration: usually given to large
tract owners. Increase supply and price
goes down. Don’t let the wells produce
more than market can absorb. Each well
has a daily allowable out of 30 days.
May produce daily allowable 20/30 days.
They had this until the 1970s when US could no longer produce all it
could use.
3.
allowables are to be set to assure that each owner can produce his fair share.
4. As long as there is substantial evidence to
support the RR commissions
findings, they will be upheld.
a. Doctrine of Extension - federal courts will
refrain from issuing injunction
against RR Commission decisions. They
stay out of it.
C. How
Pooling is Accomplished: pooling is the
combination of small tracts into a single unit large enough to qualify for a
drilling permit. Can pool royalty interest, working interest, etc.
1.
Most frequently created through a declaration to pool pursuant to the pooling power found in the
lease. However, field wide pooling is
usually y done through a
specially tailored instrument.
a. one well units - pooling together enough land
to drill one well.
b. field wide pooling - Also called unitization. Want injection wells around outer realm to push oil to
center. Get landowners to agree because doing
without permission is a breach of the covenant to protect.
i.
No one knows what to put in a lease for field wide because of the variances in
the land of each tract. Would be so
broad and general,
so probably too vague to uphold.
2.
Courts have found some instruments to provide for IMPLIED POOLING. The cases have held this where two or more
people place their
separately owned tracts under one lease.
This is a rule of construction
only, so can be negated.
3.
In
a.
Cross-conveyance: each person
whose interests are affected by the
pooling acquired a proportionate interest in the land of the others.
b.
Allocation: pooling is seen as
creating contract rights in the various
parties affected. Royalties apportioned
on the basis of the number
of acres contributed to the community lease.
Worded merely to
allocate production which is personal property and not subject to the rule against perpetuities. Considered a transfer for an interest in production.
D.
Community lease - when several landowners of adjacent tracts sing a
single lease granting mineral rights in combined acreage to a single lessee.
The execution of the lease will be treated as an agreement to POOL and each
lessor will be entitled to share in production.
Technically, when a community lease is executed, there is a
cross-conveyance whereby each landowner signing the lease conveys a fraction of
his royalty interest to his co-lessors, receiving in return, a conveyance of a
partial interest in the co-lessors
royalty rights.
E. Lease Pooling Clauses
1. The most common way that lessees
obtain the right to pool their lessors
interest is by a pooling clause in the lease.
It will usually need to contain:
a. an acreage limitation
b. a dissolution provision
c. provision for enlarging or forming a new unit
d. the unit will be formed by doing two things:
i. executing an instrument (designating a unit)
ii. filing it for RECORD. It must be recorded to be effective.
2.
The pooling clause modifies the habendum clause of the lease by providing that production
or operation anywhere on the unit formed will be considered to be production or operations on the leased
premises. Applies to one or more horizons or depths. EXCEPT for purposes of paying royalties.
3.
The pooling clause obligates the lessor to accept royalty proportionate to the amount of the leased land
included in the pooled unit. For purposes of royalty,
allocated to each tract in relation to ownership each tract bears to ownership of the whole.
4.
The general effect of pooling clause is to permit the lessee to pool or combine all or part of the leased
premises with other land for purposes of creating
an operating unit.
5.
Absent express authority, a lessee has no power to pool interest in an estate retained by the lessor with
those of the lessors.
6.
Courts read pooling clauses strictly.
It means what is says and can not
be used to establish lager units than designated by that particular lease. It is rare that parole evidence will be
allowed in to explain.
7.
GOOD FAITH: the pooling power
must be exercised in good faith, NOT utmost good faith,
considering all relevant facts and circumstances. There
is no rule of thumb. Any intent on part
of lessee to cheat? and/or look
at it overall (long-term and short-term), is it fair? The following factors are indicia of bad faith. Anyone alone is not conclusive nor is any particular
combination required. It is a fact
inquiry.
a.
pooling after production has been obtained - it cuts down what the well side owner would get.
b. Pooling just before the expiration of the
primary term - can look like you
are just trying to hold a lease.
c.
gerrymandering - pooling in extremely odd shapes, that raise attention and
seem to have no reason for their shape.
Designed to maximize
benefits of person seeking to pool.
d.
dilution pooling - the strongest indicia of bad faith. Lessee will pool two separate royalty interests to obtain an average royalty
payment, which is less for it to
pay on one of the tracts. This can
dilute the royalty.
e.
non-contiguous tracts- tracts that are not connected. Usually occurs
in conjunction with dilution pooling.
f.
perpetuation of too much acreage - pooling too much acreage to hold lease on all property in
lease.
g.
inclusion of non-producing acreage - sometimes done for sencery. To
the extent done knowingly. Want to count
this toward maximum acreage for wells. Historically, if tract included some
non-producing acreage
this is ok.
8.
Bennett: An agreement entered into due to a
pooling clause in the lease
allowing pooling. If not covered in the
lease, you need a separate pooling
agreement.
9.
Implied pooling - where two owners place their tracts under one
lease. It
can be negated.
F. Entirety Clause: a clause in an oil and gas lease or
in a deed that states the
agreement of the parties that royalties are to be apportioned in the event that the property is
subdivided after the lease is granted.
The purpose of the
clause from the viewpoint of the lessee is to make clear that the lessee’s duties will not be
increased by transfer by the lessor of a part
of the leased premises. From the
viewpoint of the lessor, the purpose
of the clause is to avoid the non-apportionment rule.
G. Compulsory Pooling - pooling effectuated by government
order. In
1.
Mineral Interest Pooling Act - applied in situations where separately owned adjacent mineral tracts within
the boundary of a productive reservoir
needed to be pooled in order to develop a leasehold sufficient in size to meet the field drilling unit
spacing and density regulation and this was
prevented because on of the owners refused to pool. Applies only to oil and gas discovered after
a.
Requirements: there is a common
reservoir, two or more separately
owned interests within the proposed proration unit, the owners have not agreed to pool, there is a well
or a proposal to drill one
by one of the owners on the unit, this unit will avoid the drilling of unnecessary wells, the reservoir was discovered and
produced subsequent to March 8, 1961, the acreage
sought to be pooled appears
to lie within the productive limits of the reservoir (acreage of all parties appears to be
productive), applicant shows he has made a fair
and reasonable offer to pool voluntarily
(ct decides reasonableness),
and applicant must be owner of some interest in the minerals or royalty, but not an unleased royalty
interest.
i.
Process: application; commission
holds its own hearing or meeting to
approve, disapprove, or approve with modifications; if anyone is unhappy with the decision, can go
to district court where land
lies. Judge will base his decision on
the administrative record alone
- no new evidence is allowed. He asks,
does it violate the law? Is the decision supported by substantial
evidence? Decision can be appealed to the
court of appeal for that area.
ii. With the exception of MIPA actions, all
appeals from the RR Commission
decisions go to the district court of
iii.
The reasonableness of an offer is reviewed under a substantial evidence
standard. An example of an unfair and
unreasonable offer
is: where an offer was made only after
the well was drilled, the
other owners had a better royalty rate, and the lessee misrepresented to the
lessor that he was required to accept the offer.
b. Decisions made by the RR commission as to
reasonableness will be
upheld unless arbitrary and capricious.
c.
To determine the commonality of a reservoir, look at the level of permeability - communication
between the pools such that they can migrate
from one to another. Even if
communication between two reservoirs
created by manmade factors, it is a common reservoir.
d.
To protect non-producing party, the court can issue a temporary pooling order
(interim). When the final order is
handed down, it relates
back to the date of the temporary order - retroactive. This is so even
though the statute appears to disallow retroactive
e. Under limited circumstances, the
court will take a MIPA case under de
novo review: when someone is stuck with
an old lease with a low royalty.
f.
An order by the commission regarding spacing units supersedes a declared unit. Therefore, where all owners of 480 acres got
a share of production,
and the commission came along and established a 160 acre spacing restriction, owners of the 160 did not
have to share with the
owners of the remaining 320. Hladik v. Lee.
H. Pooling and adverse possession: adverse possessor will divest the mineral interest, placing a well on
someone’s lease is the same as adverse possession
of the entire lease. However, if he is
not on the lessee’s land, rather on
land pooled with lessee’s land, is not in adverse possession of the total pooled land. Only that portion he can show physical
operations on. Unitization does not change the scope of adverse possession.
I. PUGH CLAUSE: A type of pooling clause which provides that
drilling operations on or
production from a pooled unit or units shall maintain the lease in force only as to lands included
within such unit or units. The lease may be maintained in force as to the remainder
of the land in any manner herein
provided for, provided that it be by rental payment, rentals shall be payable only on the number of acres not
included in such unit or units.
1.
Primarily to apply after the expiration of the primary term, unit operations will
not hold this lease in force as to acreage not included in the unit. Each lease continues in force only as to the
acreage specified in the
agreement, not necessarily the entire lease, unless the entire lease is part of the pooling agreement. “Shall maintain this lease in force only as to
land included in such unit or units.”
2.
If you do not have a Pugh Clause, you can always attempt a suit on the implied covenant to develop. Wells
v. Continental. Without the
Pugh Clause, and with a voluntary pooling agreement,
production will hod the lease
as to all land covered by the lease.
3.
A Pugh Clause takes away much of the incentive that lessees might otherwise have to try to hold large
tracts of land by creation of small, multi-lease
units.
4.
In
J. The Rights of Non-Executive
(Non-Participant/Royalty) Owners to Ratify:
1.
this problem concerns whether the owner of a royalty (or some other non-executive
interest)in part of a tract can ratify.
The right to ratify
is a property right.
2.
First, does the executive right include the power to pool the non-executive
interest?
3.
Therefore, if the non-executive right is not affected by pooling, its owner may ratify or reject
the action of the executive interest owner.
4.
The underlying rationale of this is that unless the non-executive owner has the right to
ratify, his interest will be subject to manipulation by the executive owner.
5.
When one party exceeds their authority, the person affected has the option to ratify or
disaffirm. But, only if a pooling clause
is in the lease.
6.
Rationale: Unless the
non-executive owner has the right to ratify, the
non-executive’s interest will be subject to manipulation by the executive owner so
that the value of the interest will be lost; e.g., the shape of the unit or the location of the well
may be “rigged” to minimize
or cut out entirely the royalty interest.
7.
In
K. Conflict with the Rule Against
Perpetuities: a lessor may advance the argument that the pooling or
unitization clause of a lease is void because it
conflicts with the rule against perpetuities.
The argument is that the lease
is potentially without end, so that the pooling or unitization power may be exercised after the end of all lives in being at its
creation.
1.
To prevent this, some pooling or unitization clauses impose a 21 year limit upon exercise
of the pooling or unitization power.
L. What do you do with a cost-free
interest? Many states have not addressed this, including
M. Enhanced Recovery Unitization:
N. What if lease contains no pooling
clause: Without the lessor’s approval, the lessee generally may not affect the
lessor’s rights under the lease by pooled
or unitized operations.
1.
A lessee who accepts a lease without the pooling power cannot extend it to its secondary term without drilling a
well on the leased property, even though
spacing rules do not permit drilling or geological evidence suggests drilling would
be unsuccessful.
2.
If a lessee pools its interest under a lease without a pooling clause with that of other property owners and drills a well on the
leased premises,
the lessee must account to the lessor for the full lease royalty on the production from the well,
thought its pooling agreement allocates to it
only a portion of production from the well.
Without agreement of the lessor, either in the lease or by
separate agreement, the lessee cannot affect
the lessor’s rights.
3. To pool, you need a pooling clause or a
compulsory pooling statute.
XIV. OFFSHORE LEASES
A. Inland Bays are owned by the
State
B. The Gulfbeds and Oceanbeds (Tidelands)
1.
Originally, US owned from oceanshore seaward and could grant leases.
2. No federal statute authorizing leases in
ocean.
3. Constitution gives Congress the right to hand
out land.
4. Submerged Lands Act of 1953: gave states tidelands to extend of their historic boundaries, but did
not define historic boundaries.
5.
Outer Continental Shelf Lands Act:
gave land beyond the state’s historic
boundaries to the federal government.
Where state jurisdiction ends,
federal jurisdiction begins. Allows for
competitive bidding.
a.
b.
c. All other states have jurisdiction over
tidelands out to 3 miles.
i. 12 miles up to 20 for purposes of pollution.
ii.
d.
subject to General Maritime and Admiralty Law (usually covers transportation). Laws of adjacent state are extended to the
rig (criminal
and civil), but only if federal law does not apply. BUT, can get
in to federal court because federal law adopts state law and it remains a federal
question.
6.
Federal Onshore Oil and Gas Leasing Reform Act: Instituted competitive bidding.
a.
Process: geophysical shooting,
decide what want to lease, ask Bureau
of land management to lease, lands office places land up for lease with public notice,
and they accept competitive sealed bids.
Failure
to comply allows termination of the lease.
B. Law of the Sea - indemnity in a contract
dealing with the sea is ok even if state
law prohibits it. Person servicing oil
rigs via a small boat is shallow waters.
XV. ENVIRONMENTAL DAMAGE
A. Nuisance - interference with
another’s use and enjoyment.
B. Trespass - spewing toxic chemical on
another’s land. May get punitives.
C. Negligence/Strict Liability - if have
personal injury . May get punitives and usually means big $
D. Environmental Statutes:
1.
NPDES (National Pollution
Discharge Emissions Standards) under the CWA
requires a permit to discharge from a point source pipe.
2.
CERCLA - permits government to go in and clean up and bill the responsible party. Past and present owners, operators,
generators, and transporters. Petroleum excluded, but hazardous drilling
mud probably covered.
3. OPA (Oil Pollution Act) - applies to oil
spills.
4. Technology forcing statutes - sought to force
corrections by a deadline which
is said to force the development of technology.
Doesn’t necessarily work
this way.
E. Three basic thrusts of environmental
statutes:
1. to preserve something - preserve wetlands or
endangered species
2. to control operations for the purpose of
reducing or eliminating pollution
- Ex. pollution monitoring systems
3.
to cause clean up of pollution which has already occurred - applies mostly to cleaning up soil.
XVI. White Oil Controversy
A. Gas rights in lease or field were owned by
someone other than the party owning the
oil.
B. Certain types of distillate gas in reservoir,
but oil or liquid with atmospheric
pressure and temperature.
C. Sometimes gas can be refrigerated and turned
to oil.
D. Conservation Statutes:
1.
Is an oil well if produces one barrel of oil for each 100 mcf and you
get an oil allowable. Gas is produced freely without limitation.
2.
Is a gas well if produces less than one barrel of oil for each 100 mcf and gets gas allowable. Whatever liquid is produced freely.
E. In this case, some folks refrigerated the gas
and turned it to oil claiming an oil
allowable saying ownership determined by type of well classified as for conservation purposes.
1.
For ownership purposes, don’t look to conservation, look to see if produced from oil straight
(produces more oil) or gas straight (produces more
gas).