CHAPTER 10 COMPENSATION FOR DRAINAGE FROM FEDERAL LEASES: AN INDUSTRY PERSPECTIVE ON QUESTIONS OF NOTICE, STATUTORY TIME BARS, AND LIABILITY
| Jurisdiction | United States |
(Mar 1994)
COMPENSATION FOR DRAINAGE FROM FEDERAL LEASES: AN INDUSTRY PERSPECTIVE ON QUESTIONS OF NOTICE, STATUTORY TIME BARS, AND LIABILITY
Holme Roberts & Owen LLC
Denver, Colorado
TABLE OF CONTENTS
Page
INTRODUCTION
I. ESTABLISHING NOTICE IN A DRAINAGE CASE
A. Notice as a Trigger to the Duty to Protect Against Drainage
1. Establishing Imputed Knowledge of Drainage
a. The Common Lessee Situation
b. The Non-Common Lessee Situation
2. Establishing Actual Notice of Drainage
B. Notice as a Trigger to the Right of Review
II. TIME LIMITATIONS ON ASSESSMENTS FOR COMPENSATORY ROYALTIES
A. The Applicable Statute
B. Accrual of a Cause of Action for Compensatory Royalties
C. Tolling of the Limitations Period
D. The Government's Right to Administrative Offset
III. THEORIES OF LIABILITY
A. Operating Rights Owners
B. Record Title Owners
1. The 1988 Regulatory Amendments
2. The Post-1988 Regulatory Scheme
C. Operators
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D. Interparty Liability
1. Liability Among Working Interest Owners
a. Operating Rights Held in Co-Tenancy
b. The Effect of An Operating Agreement
2. Liability Between Interest Owners Who Transfer Their Rights
a. Temporal Liability Issues
b. Concurrent Liability Issues
3. Operator Liability
CONCLUSION
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INTRODUCTION
Government actions seeking compensation for breach of the duty to protect a federal lease from drainage, provide fertile ground for dispute. Any given case can involve numerous issues, both technical and legal, resolution of which will have significant impacts on the rights of parties involved. Regardless of the specific arguments raised, however, the ultimate questions come down to whether compensation must be made, how much is owed and who should bear the burden of payment. The answers to these questions will in part turn on issues of notice, applicable statutes of limitation and allocations of liability. Since these issues, in themselves, present so much room for debate, we present each in terms of how they have been previously addressed by the courts and government agencies and how they should be addressed in the future.
I. ESTABLISHING NOTICE IN A DRAINAGE CASE
Some of the most critical issues that industry and government professionals face in federal drainage cases can be classified in general terms as "notice" issues. Although any given case may raise a variety of legal questions pertaining to notice, of primary importance are those involved in determining when a lessee's or operator's1 duty to protect against drainage is triggered and when its right to administrative review attaches. Outside of broad rulings confirming the importance of sufficient notice, there has been little guidance from either the Interior Board of Land Appeals
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("IBLA" or "Board") or the courts as to how these specific questions should be resolved. This section therefore presents the more significant issues as they arise in practice, discusses the Bureau of Land Management's ("BLM") positions on what it takes to satisfy notice requirements and offers standards for addressing the issues that currently remain unanswered.
A. Notice as a Trigger to the Duty to Protect Against Drainage
A major concern for both industry and the BLM is establishing the point at which a lessee or operator is on notice that its federal lease2 is being drained by an adjacent well. Since the pivotal Nola Grace Ptasynski decision,3 it has been well settled that the duty to protect against drainage arises "after the passage of a reasonable time subsequent to notification by the lessor that an adjoining well is draining the leasehold." Ptasynski, 63 IBLA at 256.4
This rule has its genesis in the common law prudent operator standard, which requires an operator to perform whatever actions that, under the circumstances, an operator of ordinary prudence with regard for the interests of both the lessor and lessee would reasonably be expected to perform. CSX Oil and Gas Corp., 104 IBLA 188, 196 (1988); 5 William & Meyers, Oil and Gas Law, § 806.3 (1992).5 Because no
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reasonable operator can be expected to undertake an activity to protect against drainage unless it knows or should know that drainage is occurring, neither a duty to protect nor a penalty resulting from failure to fulfill this duty can arise prior to sufficient notification of drainage. Thus, unless the obligation to protect the lease is triggered by notice and subsequent passage of a reasonable amount of time to take corrective action, a lessee cannot be required to drill a protective well nor, in the absence of such drilling, to indemnify the lessor through compensatory royalty payments. This rationale appears to be the underpinning to the notice requirement in both common law and federal drainage cases.
In the common law context, where the issue of whether notice is a prerequisite to a lessor's right of recovery has been addressed, the courts have applied the prudent operator analysis as a basis for precluding liability where notice was not established. For instance, in U.V. Industries v. Danielson, 602 P.2d 571 (Mont. 1984), the court made clear that at least in those cases where drainage is caused by a
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third party, the lessor must "bring home to the lessee the necessity of protecting the leased premises." 602 P.2d at 584.6 Notice was therefore viewed as a precondition to the duty to drill. Id.
The Danielson decision was further clarified in the more recent case of Sundheim v. Reef Oil Corp., 806. P.2d 503 (1991). In Sundheim, the court confirmed that notice is a prerequisite to the duty to protect against drainage but adopted a standard under which only "reasonable" notice is required: "before a lessee's duty to drill an offset well arises, he must have reasonable notice of the necessity to protect the leasehold." 806 P.2d at 508. Applying that standard, the court concluded that the notice need not come from the lessor and need not be in writing. Rather, it is sufficient for the lessor to prove that the lessee either knew or should have known of drainage. Id. at 508-09. As discussed below, this common law view of notice has, for the most part, been followed in federal drainage cases.
Since its early Ptasynski decision, the IBLA has consistently upheld its prudent operator rule and the principle that notice of drainage is determinative of when drilling obligations arise and when compensatory royalties begin to accrue. See McHugh and Associates (On Reconsideration), 117 IBLA 303 (January 17, 1991); Chevron U.S.A. Inc., 107 IBLA 126 (February 6, 1989); CSX, 104 IBLA 188.7
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The Board has also given limited guidance as to how the rule should be applied. In CSX, the IBLA refined the Ptasynski rule and, similar to the decision in Sundheim, held that compensatory royalties were recoverable if the BLM could show either that the lessee knew or that a reasonably prudent operator or lessee should have known that drainage was occurring. CSX, 104 IBLA at 196. Thus, "consistent with [the] a prudent operator's duty to exercise reasonable care and diligence in protecting...against drainage," the BLM can assess compensatory royalties prior to or even in the absence of formal notice if it proves that the lessee had actual or constructive knowledge of drainage.8 Id. at 198. See also Chevron, 107 IBLA at 131.
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In applying this broad principle to particular cases, the IBLA has taken various approaches in determining what factors will give rise to a charge of imputed knowledge and what the agency must do to instill actual knowledge through formal notification procedures. Although the inquiry is fact-specific, certain factors appear to be near-conclusive of knowledge whereas in others, the issue remains open-ended and subject to much debate.
1. Establishing Imputed Knowledge of Drainage
We look first to what the BLM must show to establish that a lessee or operator has constructive notice of drainage. The only direction the IBLA has provided as to the standard it will impose in determining when a reasonably prudent operator should know of drainage is its statement in CSX that "[w]hatever is notice enough to excite attention and put the party on his guard and call for inquiry, is notice of everything to which such inquiry might have led. When a person has sufficient information to lead him to a fact he shall be deemed conversant of it." CSX, 104 IBLA at 199 n.10 (quoting Wood v. Carpenter, 101 U.S. 135 (1879)).9 The uncertainty inherent in the question of imputed knowledge is amplified by the fact that the IBLA applies this standard differently depending on the amount of interest or control the federal lessee has over the draining well.
a. The Common Lessee Situation
In cases where the federal lessee also has an interest10 in the offending well (the so-called "common-lessee" situation), the IBLA has adopted a presumption of notice. Specifically, the Board presumes knowledge of drainage at the point of "first production from the offending
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well" on the basis that the lessee or operator's common interest places it in the best position for knowing if drainage is occurring. Atlantic Richfield Co. 105 IBLA 218, 226 (1988). See also Cowden Oil and Gas Properties, 126 IBLA 32 (1993); Petroleum, Inc., 115 IBLA 188 (1990). In this instance, the BLM does not bear the initial burden of presenting evidence of notice and can rely on a mere showing that the leases are in fact under common ownership or control. The burden is then on the lessee or operator to rebut the presumption and prove that he had no knowledge of drainage. Id.
It is not clear from the IBLA's decision what, precisely, the common lessee must show to successfully rebut this presumption. What we do know is that he will...
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