Oil & Gas: O&g Lease

Front 1

Granting Clause

States rights given by Lessor to Lessee, and property description.

Back 1

1st paragraph usually contains a Mother Hubbard clause ("This lease also covers and includes all land owned by Lessor adjacent to the land described above.")

Inclue small strips of land not specifically included in granting clause. In TX, large contiguous land tracts are not covered by MH.

Front 2

Habendum Clause

States duration of Lessee's interests in premises. Typically, there's a primary term (fixed period when Lessee has no obligation to drill) and secondary term (indefinite; usually linked to production).

Back 2

Discovery is not production. In TX, production means production in paying quantities.

Formula for "production in paying quantities" (PPQ) is:
Revenues - Lessor's royalty in the lease minus operating costs.

Front 3

"Temporary Cessation" Doctrine

Once PPQ is established, temporary production cessation due to "sudden stoppage of the well or some mechanical breakdown or the like" will not terminate lease.

Back 3

Key factors:
1) Short, temporary shutdown;
2) Which Lessee acts diligently to fix; and
3) Which is due to a 'mechanical breakdown or the like'

If lease contained savings clause such as "cessation of production clause", then this express clause will control.

Front 4

* Marginal Well Doctrine

Some wells produce in paying quantities some months during year. Test is "whether a reasonably prudent operator would continue to operate well to make a profit, not merely for speculation."

Back 4

As long as well is still producing some O&G, TX courts give lessees a reasonable amount of time to show well is capable of profitable production (as much as 17 mos).

Front 5

Doctrine of Repudiation (Obstruction)

If Lessor obstructs Lessee from developing the lease (e.g., locks Lessee out, aims gun at him); equitable doctrine extends lease.

Back 5

Courts add delay/obstruction period to Lessee's lease.

Front 6

Delay Rental clauses

Authorize Lessee to delay drilling or production during primary term of lease by periodically paying stipulated amount to Lessor.

Back 6

"Unless" Delay Rental Clause: creates a condition of a fee simple determinable

"Or" Delay Rental Clause: creates covenant; if Lessee fails both covenants then Lessor must sue for breach of contract [breach doesn't cause lease to automatically terminate; remedy is damages]

Front 7

If Lessor accepts a late delay rental payment, lease revives--> estopped to deny lease validity.

Back 7

Courts look at formal requirements for estoppel, ratification, or revivor before holding that Lessor's acceptance of royalty payments has revived an invalid lease.

Front 8

Notice of assignment clause protects lessor where delay rentals are timely made. However, can't rely on expired notice of assignment clause in the expired lease to save lease on assignee's half interest-- if assignee never accepted late delay rentals, nothing revives lease as to her.

Back 8

Thus, assignee becomes co-tenant with lessee. As such, assignee can lease to others, drill herself or simply wait for lessee to drill good wells and take 1/2 the profits.

Front 9

"Commencement of Drilling" Clause

Delay rental clause may state "if operations for drilling are not commenced on or before the anniversary date of this lease, the lease shall terminate unless... []."

Back 9

Whether drilling has commenced depends on:

1) Objective physical acts on leased premises
2) Done w/subjective good faith intent to continue to pursue drilling operation

Front 10

Defensive ("Savings") Clauses

To hold a lease beyond primary term, Lessee needs PPQ. If delay rentals are not holding lease, Lessee must satisfy a defensive clause.

Back 10

Most common:

- Shut-in-royalty clause
- Dry hole
- Operations and cessation of production
- Force majeure

Front 11

Shut-In Royalty Clause

When a well capable of producing gas is shut-in for lack of a market, Lessee can hold lease by paying shut-in royalties.

Back 11

Generally: shut-in royalties can only be paid on wells capable of producing in paying quantities (like a good well that awaits a pipeline connection).

Front 12

Dry Hole Clause: if Lessee drills a dry hole, he can keep lease alive by starting to drill another well on property w/in stated period of time

"If Lessee drills a dry hole, the lease shall not terminate if Lessee commences another well w/in 60 days or resumes paying delay rentals"

Back 12

Continuous Operations Clause: at end of primary term, operations have commenced and were continuing but not yet actual production

"If at the end of the primary term, oil or gas is not being produced , but Lessee is then engaged in drilling or reworking, the lease remains in force so long as operations are prosecuted w/no cessation of more than 60 consecutive days"

Cessation of Production Clause: if well ceases producing, Lessee can keep the lease alive provided Lessee commences repairs within the stated period of time.

"If production ceases, lease shall not terminate if Lessee commences additional drilling or reworking w/in 60 days"

Front 13

Lessees can tack savings clauses (use one, then another, then another, as events happen over time) as long as they do exactly what savings clause authorizes.

Back 13

Such lease clauses are construed against Lessee because the lease is almost always drafted and printed by Lessee.

Front 14

Force Majeure Clause

Excuses performance or extends time for performance, because of unforeseeable factors beyond Lessee's control. Act of force majeure has to be identified in lease and event has to prevent performance.

Back 14

* Look to see if force majeure clause covers only covenants or also conditions.

Front 15

Pooling Clause

Powerful defensive clause or savings clause. Allows Lessee to hold several tracts under lease w/production from just one well on one of tracts. Royalty (typically 1/8) from well is split between tract owners.

Pooling clause vests great discretion/power in Lessee, but courts require that pooling be exercised in "good faith."

Back 15

Clause reads:

"Lessee has the right to pool all or any part of the acreage covered by this lease w/other land in the immediate vicinity...Operations for drilling on or production from any part of such a pooled unit shall be considered as operations on or production from the land covered by this lease, whethr or not the well be located on the lease... Royalties shall be allocated on a surface acreage basis."

Front 16

PUGH Clause: tells what happens to portion of the acreage you leased that does not contain a well and is not included within a producing petroleum pool or unit. Basically, states that lease terminates in all non-producing areas when primary term ends or terminates.

"If only part of the acreage under lease is pooled, this lease shall be maintained only as to land included in the pooled unit."

Back 16

If Lessee wanted to hold the lease in effect in effect on this remaining __ acres, Lessee would have to do something else on this __ acres, such as:

(1) Paying delay rentals on it, if the lease is still w/in primary term;
(2) drilling a well on the __ acres and getting PPQ from that well;
(3) pooling that __ acres into another unit

Front 17

Pooling Clause & NPRIs

Back 17

Executive right owner, i.e., ME owner w/right to lease, has no power to pool nonparticipating interests, even tho executive right owner has the power to lease the nonparticipating interests

Front 18

Royalty Clause

Typical lease states royalties to be paid based on production valued "at the well" --> royalties are free of production costs, not post-production costs, such as dehydrating, pipeline compression costs, transportation.

Back 18

Once oil or gas produced at surface wellhead, Lessors must share subsequent costs, absent contrary lease language. Lessor of 1/8 royalty must pay 1/8 of post-production costs.

Note: Royalty owners only share in payments made for gas produced; don't share in payments made on gas not produced (might happen if a pipeline purchaser had promsied to a Lessee to take gas or pay for it, even if not taken ("take or pay" contracts)

Front 19

Royalty Clause & "Market Value" Issue

Many O&G leases contain provisions for royalty payments based on "market price at well" or "market value at well" where gas is sold or used off-premises

Back 19

"Market price" or "market value" of gas is price that similar gas currently sells for in spot market at time the gas is produced. Could differ from amount that Lessee is getting under a long-term contract. "Market Value Issue" cuts both ways.

Front 20

**Division Orders:

Division Order: tells Lessee or well operator or purchaser how to divide well proceeds among all lessors, NPRIs, working interest owners (other cotenant lessees or mineral interest owners).

Back 20

Lessee prepares D/O with calculations of fractional interest that each owner should receive (6th decimal point) and mails D/O to each owner. Each owner checks and if fractional amount appears correct, signs D/O. Lessee pays owners on the basis of D/O.

D/O as "housekeeping" device to aid in administration of lease payments, yet begins to have power to contradict and amend lease terms. D/Os are not deeds or bargained-for contracts. D/Os have own set of common laws and statutory laws governing their legal effect.

Front 21

Common Law approach to D/O

D/O binding til revoked, even if D/O provisions differ from lease language. However, Lessor could revoke a D/O that differed from lease and receive correct payments from that point forward.

Back 21

But, D/O is binding until revoked under common law.

Front 22

1991 D/O Act (applies to D/Os executed after August 26, 1991): to
clarify effect of D/Os [but also confuses issue]: 5 basic rules applied to RIOs (royalty interest owners)

1) D/Os are binding until revoked; RIOs can't get past underpayments until they revoke. RIO can always revoke mistaken D/O and get proper amount paid in future.

2) However, D/O can never contradict a lease or change or relieve Lessee's express or implied covenants (obligations) under a lease. If a provision in a D/O contradicts a lease, it is invalid. If it was never valid, a RIO can secure past underpayments as well as revoke and get correct amounts paid in the future.

Back 22

3) BUT D/O can clarify royalty settlement terms in a lease, but it can't contradict the lease. The statute expressly seems to allow a D/O based on "amount realized" or "proceeds" to amend/clarify (and seemingly contradict!) a lease royalty clause requiring payment on the basis of "market value." Legislature seemed to want to keep common law result achieved in earlier case law but distinguishes between 'clarifying' and 'contradicting' a lease

Front 23

4) Lessee/Payor owing royalty payments (or purchaser of o&g or the well operator) can withhold royalty payments w/o owing interest on the withheld money only if:

Back 23

a) There is title dispute that affects distribution of payments or a reasonable doubt that the payee has clear title; or

b) Payee refuses to sign a standard D/O that contains certain statutorily authorized items. If payee refuses to sign this standard D/O, payor may withhold payments w/o interest until D/O is signed.

Hint 23

"standard" items include:
- effect date of D/O
- property description
- fractional or decimal interest and type of interest (mineral or royalty) claimed by payee, w/title assurances;
- authority to suspend payments for title disputes;
- provisions for valuation of settlements to the payee (to "clarify" how royalties are to be paid)

Front 24

5) Lessee/payor has no right to withhold payments to a royalty owner who refuses to sign a D/O bc it contains items not authorized in the statute (in other words, it is a "sneaky" D/O that is attempting to amend the lease unilaterally, w/o negotiating with lessor). If a payor withholds payments in this situation, royalty owner shall receive interest on the withheld amounts. If royalty owner is forced to bring suit to collect payments and interest, court shall award attorney's fees to the successful payee.

Back 24

New General Rule on D/Os:

D/O is binding until revoked and it can "clarify" methods of paying royalty, but is not binding to the extent it changes or contradicts a lease (except in market value cases).