CHAPTER 3 ACQUIRING OPERATING RIGHTS FROM A LESSEE
| Jurisdiction | United States |
(May 1979)
ACQUIRING OPERATING RIGHTS FROM A LESSEE
Verity, Smith & Kearns, P.C. 902 Transamerica Building
Tucson, Arizona 85701
The initial lease agreement or exploration and option agreement between a landowner and a mineral developer may, prior to its fruition, become the subject of any number of assignments, reassignments, subleases, farm-out agreements and other arrangements by which the original lessee or optionee and its successors in interest attempt to obtain and retain differing types of interests in the property or in production from the property described in the initial agreement. This paper will consider distinctions between types of transfers and cite examples which, it is hoped, may be useful in reviewing and drafting the document by which a lessee or optionee transfers operating and other rights to a third party, who in turn assumes some or all of the obligations imposed upon the lessee or optionee by the terms of the original agreement. For purposes of simplicity, the examples are in the context of a lease agreement, operating rights under which are to be transferred by the initial lessee to a third party transferee. In instances where multiple transactions devolve from an initial lease, a separate analysis is necessary for each transaction commencing with the initial lease and proceeding in order to the present transaction, not unlike the order in which a chain of title is examined.
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The request to complete the paperwork in a transaction whereunder your principal has agreed to acquire operating rights to a mineral property by way of transfer from a lessee (rather than by lease from the owner) is often in the form of a short memorandum outlining the terms and conditions agreed upon between the parties to the pending transaction. Disconcertingly enough, it is often assumed that the transaction can be consummated in a short, simple "standard" form of assignment agreement consisting of perhaps a couple of pages but certainly not more than three or four, setting forth those items unique to the present transaction and incorporating by reference the "applicable" terms and conditions of the underlying agreements. It is more disconcerting, however, to be presented with an executed copy of a two or three-page assignment agreement with a request that you confirm that all of the rights, privileges and remedies granted the lessee under the original mining lease are now vested in your principal, subject only to whatever rights may be reserved to your principal's transferor in the instrument so furnished. Whether your task is to draft or to review the instrument evidencing the present transaction, it frequently becomes necessary to pass along to your principal the disappointing news that its rights and remedies are not as had been originally envisioned.
The label given to instruments whereunder predecessors in interest attempt to retain an economic or reversionary interest in the property may run the gamut from no attempt to identify the same (i.e., "Agreement") to a designation indicating that the particular transaction is intended as an assignment, a sublease, a farm-out or operating agreement. Such documents may reserve a net profits or a production royalty and oftentimes vest a reversionary interest in the granting party. Regardless of the label given to the particular document, a definition of the rights, obligations and remedies available to the acquiring party requires, in
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the first instance, an analysis of not only the instrument itself but also all preceding instruments back to and including the original lease.
As a starting point, and to introduce an element of simplification into both the analysis and the subsequent explanation, it is often helpful to characterize the instrument of transfer as being either in the nature of an assignment or, alternatively, in the nature of a sublease.
The Distinction: Assignment vis-a-vis Sublease
Those who, in a bygone era, attended the University of Arizona Law School or took the state's bar exam refresher course from the late Professor Chester H. Smith were exposed to something more basic than black letter hornbook law — namely, Professor Smith's "Legal Gems." Professor Smith described his Legal Gems as "fundamental principles which describe the nature ... and which determine the rights of the parties" concerning the subject to which the Gem applied.1 In the spirit of, but with apologies to, Professor Smith, a determination of the rights and obligations resulting from the application of the assignment-sublease distinction are summarized as follows:
An assignee assumes liability to the owner for the covenants contained in the original lease on the basis of privity of contract and estate.2 By way of contrast, a sublessee's liability to the owner on the covenants contained in the original lease arises, if at all, under third party beneficiary theories since no privity exists between the owner and the sublessee.3
The lessee-assignor's primary liability to the owner on the covenants contained in the original lease extends only to performances due prior to the assignment.4 The
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lessee-sublessor is liable to the owner for performance of all of the express covenants of the original lease, including those assumed by the sublessee in the sublease.5
An assignee assumes responsibility for performance of of all of the original lease covenants.6 A sublessee's responsibility is limited to those of the original lease covenants assumed under the sublease.7
Thus, if a third party acquires its rights by an assignment, it steps into the shoes of the original lessee and is directly liable to the owner for any breaches or failures of performance. Conversely, the resulting privity of contract permits the assignee to enforce directly against the owner any covenants made by the owner in the original mining lease.
If the original lessee transfers its operating rights for a term less than the entire term of the original lease, such a transfer constitutes a sublease.8 Although covenants running with the land of which the sublessee has actual or constructive notice remain enforceable by the owner against the sublessee,9 the express or implied covenants contained in or arising out of the original mining lease are not enforceable against the sublessee under contractual theories. Though courts have permitted the original owner to proceed directly against the sublessee under a third party beneficiary theory,10 the owner's action is necessarily limited to those obligations assumed under the sublease since the rights and obligations of the sublessee are governed by the sublease and not by the original lease. Equally important to the sublessee is the existence of a corresponding limitation on the rights of and remedies available to the sublessee, such rights and remedies being limited by the terms of the sublease agreement.11
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The Results: Examples of Application of the Distinction
In some instances, the assignment-sublease distinction may be of minor importance. If, for example, the transferee expressly assumes all of the obligations contained in the original lease, the particular theory under which the owner is entitled to enforce the lease obligations is of little consequence to the transferee. If, however, the parties to the pending transaction desire to incorporate provisions in their particular transaction inconsistent with or unanticipated under the terms and conditions of the original lease, the distinction may be of more than passing importance.
Express Covenants (and Avoidance Thereof)
A lessee may wish to interest a third party in financing further exploration of the leased premises and the third party may be willing (or even eager) to take a limited "look see" but unwilling to commit itself to the total development obligations contained in the original lease. Or perhaps the...
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