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Rethinking the Drafting of Oil and Gas Leases (the price of glue)


Long ago, oil companies purchased oil and gas leases with a 1/8th royalty, a ten-year primary term, annual delay rentals of $1.00 per acre, and on pre-printed forms (usually called Producers 88s).


My, how times have changed!


Bonuses, of course, are significantly higher. Primary terms are shorter and much language in the lease is devoted to the deductibility (or non-deductibility) of post-production costs from the landowner’s royalty and the release of non-developed acreage after the expiration of the primary term (variously referred to as pugh clauses, freestone riders, continuous development clauses, and retained acreage clauses).


Often, landowners choose to “cut and paste” from an old lease form or employ individuals to assist them in their negotiations who have little or no experience in writing complex contract provisions. Well, it is time to re-think the price of that “glue.”

On December 18th our Texas Supreme Court handed down a decision interpreting a continuous development clause to be hopelessly ambiguous and therefore unenforceable – and this should wake up all draftsmen and negotiators, both good and bad. The case is styled Endeavor Energy Resources, LP v. Energen Resources Corporation et al (Tex. Sup. Ct. Docket No. 18-1187).


Here’s what happened:


The landowner (the lessor) of an 11,300 acre ranch in Howard County, Texas, executed an oil and gas lease that was ultimately assigned to Endeavor (the lessee). Among numerous provisions, the lease contained a “continuous development” clause. The purpose of the clause was to require Endeavor to engage in a pre-ordained drilling schedule or the governing lease would lapse as to that part of the ranch that had not been developed. For reference, here is the governing language the Court was tasked with interpreting:


"(c) This lease shall terminated as to all non-dedicated acreage any time a subsequent well is not commenced within one hundred fifty (150) days from the completion of the preceding well. Each well herein provided to be drilled, once spudded, shall thereafter be drilled with reasonable and continuous diligence to a depth below three thousand five hundred one feet (3501’) below the surface and shall be deemed to be completed ten (10) days after the drilling rig moves off the hole or upon removal of the completion rig, whichever is sooner. Lessee [Endeavor] shall have the right to accumulate unused days in any 150-day term during the continuous development program in order to extend the next allowed 150-day term between the completion of one well and the drilling of the subsequent well."


I sometimes refer to the rolling of “unused days” between drilling operations as “banking” and often counsel my clients, both landowners and operators, of the complexity of drafting a clear and concise banking provision. This case justifies my caution.


Between the drilling of the 12th and 13th well, Endeavor took a “break” of 320-days, far more, of course, than 150-days. Endeavor’s justification was that it took the contractually provided 150-days plus 36 unused days between the drilling of the 11th and 12th days plus 134 days that it contended it had accumulated from earlier wells (wells 1-10) that had been drilled in advance of their respective earlier 150-day intervals, for a total of 320-days.


Energen read the lease, a contract, to provide that only the “banked” days from the immediately preceeding well (between the 11th and 12th well) could be applied to the bank or credit between wells 12 and 13. Accordingly, Endeavor had only 186-days (the 150-days in the contract plus the 36 unused days between the drilling of the 12th and 13th well), and therefore Endeavor was late in commencing well number 13th and Endeavor’s lease had lapsed as to non-developed acreage. Based on its reading, Energen acquired a new lease covering the non-developed acreage paying, no doubt, a substantial bonus.


When presented with a demand for a release, by Energen, Endeavor responded – “NO.” Endeavor argued that the “bank” of days included not only the days between wells 12 and 13 but also days accumulated from earlier wells.


No doubt, correspondence was exchanged between Energen and Endeavor where both expressed the obvious – that clearly the other side was wrong in its interpretation.


OBVIOUSLY, CLEARLY. Here is a “spoiler alert” for managers – whenever everyone on your side says it is “obvious and clear” and the other side says it is “obvious and clear,” then it is probably not obvious and clear. Check your last legal fee for a complex lawsuit – did you engage in that activity even after your counsel told you “you have a sure loser on that one”? Oh, and another thing – contracts are interpreted by judges and juries, not by “voice vote.”


Anyway, it being worth the money, litigation ensued. The trial court ruled for Energen, adopting Energen’s interpretation; the court of appeals ruled for Energen, adopting Energen’s interpretation – and then, (drumroll, please), the Texas Supreme Court took a stab at it.


In layman’s terms, the Supreme Court ruled that both sides had pretty good arguments and that the clause in question could be reasonably read either way. Accordingly, the clause was ambiguous as a matter of law. And, the Supreme Court noted, a rule of contractual interpretation is that contractual language will not be held to automatically terminate the leasehold estate unless that language can be given no other reasonable construction than one which works such result. And (always an “and”) since the clause in question, if exercised, would automatically terminate Endeavor’s property rights [something referred to as a fee simple determinable] and because the clause can reasonably be read so that Endeavor’s property rights will not lapse and the clause WILL NOT BE ENFORCED. In short, Energen loses and Endeavor wins.


The Court chastised both sides for “throw away sentences,” such as “a bizarre alternating pattern of extendable and non-extendable terms … bereft of discernible purpose.” The Court spends a fair amount of time explaining that the word “accumulate” can mean a gradual building over time, but can also be meant to describe increases in general, whether gradual, sudden, incremental, or otherwise.


In summary, the Court notes that “This case is before us after years of litigation precisely because the parties did not carefully state their agreement in unmistakable terms.” Damning language directed not only at the litigants but also at the draftsmen and negotiators of the offending clause.


So, where does this leave us? Endeavor keeps its lease; the clause is inoperative. Energen has a worthless “top lease.” Energen can politely ask the landowner to return the bonus monies paid [good luck with that one]. Of course, Energen can, depending on the warranty clause (or absence of warranty clause), sue the landowner for a return of the bonus. Perhaps, Energen should hope that the same draftsman or negotiator that represented the landowner the first time around was chosen, again, to negotiate the lease with Energen. And, irrespective of the language of its lease and its rights, Energen will “enhance” its reputation throughout the landowner community by suing for a return of its oil and gas lease bonus. And, of course, Energen will incur a second round of expensive litigation fees. In short, Energen probably purchased “a bunch of nothing.”

All so often I see leases that are the result of “cut and paste” works. Prior oil and gas leases are freely borrowed from, are full of clauses cobbled together, full of ill-defined and duplicative “defined terms” (e.g. the Lands followed by the Leases followed by the Described Acreage followed by the Leasehold, which appear to all refer to the same thing but maybe not), and are full of ambiguous, contradictory, and nonsensical terms. This is no way to “run a railroad.” Especially, when money is involved.


My advice to a landowner, when offered an oil and gas lease, is to get the bonus, the royalty, the primary term, and a copy of the proposed lease. Then hire an experienced lawyer (and perhaps others) to determine the reasonableness of the terms and to negotiate the final contract/lease. As a general rule, landowners should try to avoid the “banking” or “rolling over” of unused days between the drilling of wells when drafting a continuous drilling obligation – it is just too difficult to draft and too difficult to enforce. Consider instead 180-days instead of 150-days with no banking. Also, be sure to limit your “warranty of title,” otherwise you may be called upon to return the bonus if there is “title failure.” You’d be surprised how often landowners, who don’t know what they own, give a full warranty of title.


For the oil company, draft your own continuous drilling obligation clause (along with your own post-production costs clause), and make sure it is “reasonable” – satisfying not only your needs but also acknowledging that in this “new day” landowners are going to demand some things they might not have even thought about 30 years ago. If the lease bonus is $10,000 an acre and the landowner owns ten acres, that is $100,000. You should assume that Farmer Bill will consult with someone, although not necessarily a “smart someone.” There is a practical advantage of preparing the first draft. Always try to do that, but again, don’t present oneself, as one oil company recently presented itself to me, that it had never executed an oil and gas lease that did not contain a full warranty of title. I knew that was not the case because I looked up leases it had signed on Texasfile.


If both sides don’t “break a few eggs” (e.g. spend some time and money setting down in writing what they want and actually agreeing upon something), then they will find that the price of glue (e.g. the defective “cut and paste” job) is, indeed, quite high.


by Jack M. Wilhelm


Edward Wilhelm and Jack Wilhelm provide tremendously high value legal assistance to a large number of very desirable clients.


THE WILHELM LAW FIRM, 5524 Bee Caves Road, Suite B5, Austin, TX 78746; (512) 236 8400 (phone); (512) 236 8404 (fax); www.wilhelmlaw.net


DISCLAIMER: The information on this site is not intended to and does not offer legal advice, legal recommendations, or legal representation on any matter. You need to consult an attorney in person for legal advice regarding your individual situation.

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Wilhelm Law Firm, 5524 Bee Caves Rd., Ste B-5, Austin, TX 78746 (512) 236-8400