Oil and Gas Lease Flashcards
Granting Clause
Sets forth the rights given by lessor to lessee and a description of the property
*Mother Hubbard Clause
First paragraph usually contains a clause to pick up small strips of land not specifically included in the granting clause b/c of mistakes in surveys or descriptions
*Habendum Clause
Sets the duration of lessee’s interests in the premises
Typically there is:
(i) primary term = fixed period during which lessee has no obligations to conduct drilling operations
(ii) secondary term = indefinite but normally linked to production
*Production in Paying Quantities (PPQ)
≠ mere drilling
≠ mere discovery
Production = production in paying quantities (revenues minus lessor’s royalty minus operating costs)
Construction of O/G Lease
O/G leases are construed against the lessee, unlike typical Ks
O/G leases are usually drafted by the oil company
*Common Law Exceptions to PPQ
(1) Temporary Cessation Doctrine = once PPQ is established, a temp cessation due to a sudden stoppage of the well or some mechanical breakdown or the like will not terminate lease
- short, temporary shutdown
- which lessee acts diligently to fix
- that is due to a mechanical breakdown or the like
(2) Marginal Well Doctrine = some wells only produce PPQ during some months of the year; test = whether a reasonably prudent operator would continue to operate the well to make a profit, not merely for speculation
(3) Doctrine of Repudiation = equitable rule that can extend the lease if the lessor obstructs the lessee from developing the lease
Reasonableness Standard
Reasonably prudent operator
*Delay Rental Clauses
Authorize lessee to delay drilling or commencing production during the primary term by periodically paying a stipulated amount to the lessor
“Unless” vs. “Or” Delay Rental Clauses
(1) Unless:
If the clause states “The lease shall terminate UNLESS lessee shall pay lessor the sum of $ in delay rentals,” then the clause creates a condition of the lease (i.e., FSD)
Remedy = lease terminates automatically
(2) Or:
If the clause states “Lessee agrees to either drill a well OR pay delay rentals,” then the clause only creates a covenant b/w lessor and lessee, and the lease does not terminate automatically
Remedy = lessor must sue for breach of K; damages would be equal to the unpaid amount of rentals
Late Delay Rentals
If lessor accepts a late delay rental payment, the lease comes alive again, based on a loose theory of estoppel
Usually requires some proof of an act by lessor (i.e., cashing the check) upon which lessee has detrimentally relied
Notice of Assignment Clause
Some leases may contain a clause that allows one or both parties to assign their rights under the lease, but no change in ownership is binding on the other party until a certain time after notice of the assignment
Commencement of Drilling Clause
If the delay rental clause states that “if operations for drilling are not commenced on or before [date], the lease shall terminate unless,” lessee pays delay rentals.
Commencement depends on two factors:
(1) objective physical acts done on the leased premises (e.g., building a road, cutting down trees)
(2) subjective good faith intent to pursue the drilling operation
*Defensive or Savings Clauses
To hold a lease beyond the primary term, the lessee needs PPQ. If delay rentals are not holding the lease, then the lessee must satisfy a defensive or savings clause
(1) Shut-In Royalty Clause = when a well ceases PPQ due to market conditions, the lessee can hold the lease by paying shut-in royalties
(2) Dry Hole Clause = if lessee drills a dry hole, she can maintain the lease by starting to drill another well w/in the stated time
(3) Continuous Operations Clause = covers the situation where at the end of the primary term operations have commenced, but there was notyet actual production
(4) Cessation of Production Clause = provides that if a well ceases producing, lessee can maintain the lease by commencing repairs w/in the stated time
(5) Force Majeure Clause = excuses performance or extends the time for performance b/c of unforeseeable factors beyond lessee’s control
Lessees can tack their savings clauses together over time
*Pooling Clause
Allows lessee to hold several tracts under the lease w/ PPQ from just one well of the tracts
Royalty from the one well is typically split b/w the various tract owners
Courts require that the lessee exercise pooling in good faith
*Pooling Clause and NPRIs
The executive right owner has no power to pool the non-participating interests, even though he has the power to lease the non-participating interests
*Pugh Clause
If only part of leased acreage is pooled, the rest shall be severed unless lessee drills or pays delay rentals on remainder
The Pugh clause releases the un-pooled acreage and states that lessee will need to indepdently keep that
un-pooled acreage alive, either via drilling a well resulting in production or via another
savings clause.
If the lessee fails to do so, the un-pooled acreage will be released and the lease can terminate as to that acreage upon the end of the primary term.
*Cost-Free Nature of Royalties
Royalties are free of the costs of production
Royalties are not free of post-production costs, such as transportation
Absent contrary language, lessors must share post-production costs in proportion to their royalty interest
*Royalty Clause and “Market Value”
Many leases provide for royalty payments based on the “market value at the well” where the minerals are sold or used off-premises
Market value of O/G = price that similar minerals currently sell for in the spot market at the time the O/G is produced
Amount of royalty can differ from the fractional amount of what the minerals are actually sold for under a long term K
*Division Orders
D/O tells the lessee how to divide the proceeds from the well among all the various lessors, NPRIs, and working interest owners
Lessee prepares the D/O for each owner; if the owners sign the D/O as correct, the lessor then pays the owners their checks on the basis of the D/O
≠ deeds or Ks, but they have their own set of laws governing their legal effect (unique to O/G law)
*Common Law Approach to D/O
D/Os are binding until revoked, even if the provisions differed from the lease language.
Lessor was required to revoke an inconsistent D/O to receive correct payments going forward. Can’t get past underpayments.
*1991 D/O Act
Applies to D/Os executed after 1991
Applies to royalty interest owners (RIOs)
(1) D/Os are binding until revoked, but
(2) D/Os can never contradict a lease. If it does, it is invalid. If it was never valid, a RIO can get past underpayments
