CHAPTER 3 NEGOTIATING THE OIL AND GAS LEASE FROM THE LANDOWNER'S PERSPECTIVE
| Jurisdiction | United States |
NEGOTIATING THE OIL AND GAS LEASE FROM THE LANDOWNER'S PERSPECTIVE
Graves, Dougherty, Hearon & Moody, P.C.
Austin, TX
(with special thanks to Terry Cross)
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JOHN B. MCFARLAND represents land and mineral owners in oil, gas and mineral law, water law, and environmental law issues, in both transactional and litigation matters. He was Briefing Attorney to the Honorable Ruel C. Walker and to the Honorable Ross E. Doughty, Supreme Court of Texas, 1975-1976. He obtained Board Certification as a Specialist in Oil, Gas and Mineral Law in December 1986. Mr. McFarland is the author of the Oil and Gas Lawyer Blog. He has been a shareholder with Graves, Dougherty, Hearon & Moody in Austin, Texas since 1978, and was President of the firm from January 2018 to April 2019.
I. Introduction
Oil and gas leases are negotiable. They always have been, but the scope of those negotiations has changed dramatically from when mineral owners assumed that the Producers 88 form,1 with its 1/8 royalty fraction, was "standard" and the only negotiations were likely over the bonus. A lessor who held out until the neighbors were all signed up might have gotten a few extra dollars as bonus in the leasing transaction but rarely would have aspired to rewrite or add to the basic provisions of the standard form.
Today, negotiations are the norm for not only the financial terms (bonus, royalty fraction, shut-in payments, surface damages, etc.) but also for the operative language used throughout the lease. Sophisticated lessors have their own lease forms and even the owners of small tracts develop detailed requests, often in the form of an addendum to the lessee's form, for new provisions and modifications of the boilerplate provisions.
The movement away from the "standard" Producer's 88 lease form is not new, and it has many causes. First, there has never been a standard Producer's 88 lease form. For many years the most common forms were those published by Pound Printing & Stationery Company. There were several Pound forms, and those forms changed over time. The forms were written by exploration companies and the lawyers representing them. As landowners learned of the shortcomings of those forms from a landowner's perspective, they and their counsel developed "riders" used to ameliorate the most lessee-friendly provisions of the printed form, such as the Pugh clause and restrictions on pooling. Riders also addressed issues relating to surface operations, not addressed at all in the Pound form.
Landowners with large holdings have negotiated non-standard lease agreements since the beginning of oil and gas exploration. Far more detailed than a "standard" oil company form, these leases contain provisions for exploration and development, measurement of production, accounting for royalties, use of the surface, compliance with laws and regulations, indemnities, insurance, etc.
Over the last 25 years, oil companies have developed their own "standard" lease forms. Bank trust departments have their "standard" lease forms. With the recent acquisitions of minerals by large well-funded mineral buyers, mineral acquisition companies now have their "standard" form.
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It is true that "standard" lease forms make administration of large lease blocks easier. Such leases can be treated as a commodity asset and traded among producers as such. But I disagree that these advantages outweigh gains to the lessor from using non-standard lease forms. A lease is a contract. A well-constructed lease, negotiated between parties who understand the industry and their relative bargaining power, allocates the risks and benefits between the parties. Each party then receives what it bargained for. While landowners must understand the lessee's need for some uniformity in lease terms, a well-crafted lease balances that need against the individual landowner's goal of maximizing the benefit of its mineral estate. Because Texas has only very limited forced pooling, landowners in Texas have the greatest freedom of any state to negotiate lease terms to their liking. Texas nevertheless is and has been the most successful of any state in developing its privately owned oil and gas resources. And, although I don't have statistics to prove it, I believe that Texas landowners receive a larger share of the benefits of mineral exploitation than do landowners in other states.
I also do not believe that claims and controversies are more likely because of the growth in use of non-standard lease forms. Controversies related to oil and gas leases have always been and will always be with us. Many such claims arise out of "standard" lease forms, and many of those claims arose because the lease form did not adequately address the rights and obligations of the parties. Courts were left to guess the parties' intent. And controversies continue to arise out of "standard" lease forms because of changes in drilling technology that were not known when the lease was signed.
A poorly drafted lease will always invite controversy. Lease buyers willing to accept a poorly drafted lease form just to "get the acreage" are as much at fault as the landowner (or landowner's counsel) who uses the poorly drafted form.
Landowners in Texas have also paid more attention to the lease form because of a shift in court-made law construing "standard" lease provisions - in particular the royalty clause. Landowners can no longer assume that a court will construe an oil and gas lease to carry out the overall intent of the parties. The cannons of lease construction have evolved over time to favor the lessee. In response, landowners' counsel have drafted more detailed lease provisions to protect their clients' interests.
II. The Leasing Process-
The lessee initially proposes the lease form, but sophisticated or large mineral owners may respond with their own lease form. To the extent that the lessor chooses to negotiate for additional or different lease provisions than are offered by the lessee, often the new provisions are added by way of an addendum rather than weaving the modifications into the relevant portions of the lease form. No matter how the negotiated changes are documented, the new or different provisions must be integrated into the lease.
The exigencies of the leasing process often tempt all involved to use the seductive bolt-on addendum that begins with "[n]otwithstanding any provision of the pre-printed form to the contrary, the terms of this addendum shall govern...." Even without that preface, the mere fact that the addendum provisions are tagged onto the preprinted form generally will result in the rider language having priority over conflicting provisions in the form.2 However, when creating or adopting language for the addendum, some thought should be given to the boilerplate form provisions that cover the same subject area and to whether the negotiated "trumping" provision should totally supplant the provisions covering the same or related provisions within the form. And if it should supplant preprinted provisions, does it? The addendum provision will control only to the extent of a conflict and Texas courts (at least) will strain to avoid finding any conflict:
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[C]ourts should examine and consider the entire writing in an effort to harmonize and give effect to all the provisions of the contract so that none will be rendered meaningless. No single provision taken alone will be given controlling effect; rather, all the provisions must be considered with reference to the whole instrument. 3
Saying that the addendum provisions govern to the extent of a conflict allows somebody other than the parties to decide whether there is a conflict and the extent of the conflict. If the addendum is supplying the royalty clause or the pooling clause, consider explicitly deleting the supplanted language from the lease form to avoid a court straining to reconcile all "eight corners" of the form and the addendum.
If a provision in the addendum conflicts with express provisions of the form, even if the addendum language will control to the extent of the conflict, the modification may still cause problems. The modification of one provision may change an assumption that supports another provision. The addendum can "control" and match the negotiated terms, but still result in unintended consequences if the change is not fully integrated in all relevant portions of the lease. Examples of the failure to make bolt-on provisions mesh with the rest of the lease include "retained acreage" provisions that have different area provisions than the pooling clause and the selection of different deadlines for a continuous drilling provision than set forth in the operations provisions (e.g., 90 days in one and 60 days in the other). Lessors may also be disappointed to find that add-on provisions regarding development, marketing matters, etc., may actually preclude implied covenants that otherwise would have arisen and would have been more generous to the lessor than the inserted express covenants on those subjects.
III. Show Me the Money- The Bonus
Probably the most vigorously negotiated term of the lease is the bonus, or purchase price, to be paid for the lease. Yet neither the amount of the bonus nor the commitment to pay bonus is set forth in the lease itself. In the real estate industry, the logistical issues related to handling the exchange of the deed for the purchase price are addressed through the use of title companies and escrow arrangements. In oil and gas leasing transactions, the mineral owner and the lessee's representative usually deal directly, which leaves the exchange of the lease for the bonus unscripted. The optimum approach for the lessor is to get cash on the barrel head (or immediately available funds) when lessor delivers the executed lease. The best approach for the lessee is to have a binding commitment from the lessor...
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