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.  Texas was originally a crown state, but adopted three     exceptions to the Crown Rule:

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. Ohio Oil:  If it migrates across a property line, you lose title.  Drilling on own property, but deliberately drilling angularly to tap another’s pool is clear trespass.  An unintentional slant is OK.

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 Texas and Louisiana to Kentucky.  Gas maintained in a reservoir.  Financing statement giving interest in reserved oil to defendant for a loan.  When previously extracted oil and gas is stored underground, title to it is personal and does not become real estate.

a.  Hammonds:  Oil company injects into a reservoir under their property.  Oil migrates across property line and Hammonds seeks damages for trespass.  Court says no action for trespass because once crosses line, Hammond owns it. (KENTUCKY RULE)

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.  Texas courts are not sure what the result would be if conservation statutes directly negated correlative rights, but other states suggest that conservation should win.

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 Arkansas.

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 Texas.

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, W. Va.) Some states have borrowed half this view and held that for gas, discovery is all that is required, but for oil you still need actual production (MO, WY, TN).  MAJORITY: If only have a habendum, can’t wait until last day to drill.  Must have drill and reproduction before primary term ends.

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.  Clifton v. Koontz:  Test for a marginal well - whether a reasonably prudent operator for purpose of making a profit, would continue to operate the well in the manner in which it is  operated.  Speculation does not count - not making profit but holding because someone might find deeper formation nearby that can be tapped into.

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 - Rogers v. Osborn.

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.  Ohio court held a lease that had failed to produce for 3 years because of water in the      borehole had permanently ceased to produce.  Wagner v. Smith.

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. Harrison:  No change of ownership shall be binding upon lessee until 30 days after lessee receives notice         of the change and documentation.  Gives lessee time to get with heirs and see how you need to pay it. 

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.  Cheyenne v. Criswell:  Repudiation by lessor tolls the lease - relieves the lessee from any obligation to conduct any operation until the matter is settled.

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 - Rogers v. Osborn.

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.  Tex allows this even where there is no                  title or value dispute.   BUT you cannot have a lease amendment in                         the division order.

E.  The Market Value Problem: 

1.  This occurs where one is determining the market price at the well.                        In Texas, market value is not determined by the sales contract price,                     but is determined by the currently price of similar gas sold in the area.                     So, in Texas, the market value means market value at the well less                   costs subsequent to production, not the amount realized.  Subsequent                   cost which are deducted:

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.” (Louisiana). “An economic benefit accruing from the leased land, generated solely by virtue of the lease, and which is not expressly negated,... is to be shared between the lessor and lessee in the fractional division contemplated by the lease.”

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 Texas, the covenants in implied in FACT (rather than law) as a part of the contractual provision of the lease, as necessary in order to effectuate the intentions of the parties.

                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 Texas.

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 Texas, the remedy at law is generally adequate, so it rarely                                         cancels a lease.  Usually get damages.

b.  If legal remedy insufficient, Texas will follow the Kansas rule                                        and issue an alternative decree giving lessor one last chance to                                drill the offset well or lose the lease.

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 Louisiana because courts hold that development is the purpose of the lease, without it, the lease is void.

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.  Bristol v. Colorado Oil:  7.5 years considered a reasonable time, so if have a secondary term you are OK. (OK and TX).  Even if there is a ready buyer, it may be prudent for a producer to wait to get better terms or to deal with another purchaser;         decline of demand for natural gas in times of economic recession does not fall equally upon all gas purchasers.

ii.  Lessee has a good faith duty to obtain the highest price for the product.  Amoco v. First Baptist Church.  Here, defendant had to go back and pay fair market value of the oil at the time delivered because Amoco negotiated a sell of oil and gas when economic conditions were poor.  Amoco committed several undeveloped leases to a contract in 1969 when prices low.  In 1974, when market higher, they renegotiated and added leases to the contract to increase the contract price.  Some owners were getting a substantial amount more than others (the leases added in 1974).

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 (Texas).  You do not                    have to show deadlock.  Applies to any estate in land.

                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 Texas, there is a statute that controls the distribution of proceeds.                       Applies only to leases not in effect at time of owner’s death which are                     created by the trust.

                        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 Texas, unless trust interest expressly negates it, trustee has the                      right to execute an oil and gas lease.

                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 Texas.  Even you label it as a power, it will remain a right.

                1.  Since in Texas it   s a property right, the rule against perpetuities is not                      a problem but in states that label it as a power there can be a problem.

                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 Sept. 1, 1895, conveyed all minerals

                2.  Patent after Sept. 1, 1895, state maintained mineral rights to land                          labeled as mineral bearing.

                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.                         Oklahoma says it only includes things similar to oil and gas.  Coal is not.

                2.  Texas has rejected the ejusdem genres rule and has adopted two                                 tests depending on the time of the severance.  Tests are not retroactive,                    the date the minerals were severed is the date used to determine which                   test to use.

                        a.  Surface Destruction Test:  severance prior to June 8, 1983.  If                                       substance is at or near the surface so that extraction would, as of the                                 time of removal, consume, destroy, or deplete the surface, the                                           substance is part of the surface estate.  In other words, if by any                                      method of mining in use at the time, surface is destroyed, the surface                                owner owns the minerals.

                                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 June 8,                                     1983.  Owner of the unnamed mineral has a right to reasonable use of                                the surface subject to the DUE REGARD test so long as he                                                        compensates the surface owner for any destruction.  Items the court                               has found to belong to the surface owner (regardless of whether pre                          -1983 or post -1983) or nonminerals:

                                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 Texas tests do not apply to minerals reserved by the state.                            When the state reserves all minerals, this means all minerals.

                        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 Texas courts have taken a such a literal approach to                                      interpreting conveyances, a great deal can depend on the choice of                             words.

                        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 Utah and North Dakota, courts have ignored this rule where                                    the grantee knew or ought to have known about the outstanding                                   interest.

    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.  Alabama defines it as the full 1/8 royalty on an acre of land.

                                        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. - Concord.

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 Ontario Canada.

                        e.  In Oklahoma, conservation statutes provide specifically that all                                   owners of property included in a spacing unit will receive their royalty                              on production.

                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 Texas because the bottom                                                  lease may be extended by production for a period of time                                                    greater than that allowed by the rule.

                                                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.  Texas legislature abolished the Rule in Shelley’s Case -                                                  estate (fee) tail, perpetuity and monopoly are still enforced.

                                                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 Texas, a trespasser                   may be held liable for damages to the speculative value of the rightful                     owner’s mineral interest .  Humble Oil, with the consent of one of the                       cotenants drilled a dry hole on a lease.  As a result the speculative                           value of the mineral interest declined.  The court held that Humble had                    trespassed on the interest of the nonconsenting mineral estate owner.                    The mineral owner was entitled to damages equal to the decline in the                     speculative value of his lease caused by the drilling of a dry hole.

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 Texas, the good faith trespasser may not recover the costs of                  drilling a dry hole or conducting other unsuccessful operations that do               not benefit the true owner.

b.  If expenses exceed the production, some courts allow a good faith                      trespasser to have a lien on future production.

                        c.  Texas also has a statute which gives a good faith trespasser, who has been in possession for at least one year, an affirmative claim for improvements if permanent and valuable.  Oil wells do fit in here (permanent and valuable).  If not in possession one year or this comes up collaterally in a suit, the statute does not apply.  Defensive right would kick in and keep capital and operation costs from the proceeds.

                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 Texas, a person who enters onto a disputed tract of land and                            drills during pendency of a lawsuit is in bad faith as a matter of law.                       This does not apply to a cotenant.

                        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 Texas)

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

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 Louisiana.

                                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 Texas, implied covenants run with the land.  The implied                                           covenant to develop really does not matter.

                        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. - Johnston.

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 Richfield.

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 Texas will not apply if you are negligent, but can through a written agreement which is supported by liability insurance.

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 New Mexico, an operator may not be                                        indemnified against his own negligence.

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, Tex. did not have a forced pooling statute until 1965.  The main conflict developed in what allowable would be given to the small tract owner.  The         RR commission compromised and gave the small owners a large enough allowable that would allow them to make a profit, but gave the larger tract proration.  It was argued that these allowed confiscation (drainage) by the small , so the courts said:

                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 Texas, there is no equitable pooling.  Texas follows allocation                  pooling and not cross conveyance pooling which can be subject to the                  rule against perpetuities.

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       Texas, only applies to one well units.  In Louisiana, can use for both one well and field wide units.

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 March 8, 1961.

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 Travis County.

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.  Carson v. RR Comm.

                        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.  Tex would probably                        hold the same way - spacing forced unit will probably supersede a                           declared voluntary unit.

        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 Texas, compulsory pooling - production will hold the lease as to all                lease acreage if a voluntary unit would have held it.  Assuming Pugh                      clause not limited to voluntary units.

        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?  Texas courts have held that it does not.                            Brown v. Smith.  Non-participant must ratify first before can pool the                      royalty.  Need non-participants permission.

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 Louisiana, the self-interest of the executive and the power of the                     courts to intervene to protect the non-executive against bad faith or                      imprudent exercise of the executive right will be sufficient to protect                        the non-executive.

        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.  Utah           and Kansas have rejected this argument on the basis that the lease                         created a vested present estate that is not subject to the rule.  It other             states it is not clear.

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 Texas.  Some courts have equalized them. 

        M.  Enhanced Recovery Unitization:  Texas lacks a compulsory unitization     statute that can be used to force all owner in a field to unitize for secondary   recovery.

        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.  Texas - under Spanish law, claim of land out to 3 nautical miles.

                b.  Texas and Florida have historic claims as to the gulf coast, but not                     the Atlantic.

                        c.  All other states have jurisdiction over tidelands out to 3 miles.

                                i.  12 miles up to 20 for purposes of pollution.

                                ii.  Clinton signed a bill granting state ownership out to 24 miles.

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).