CHAPTER 3 PERFORMANCE OF THE LEASE ROYALTY CLAUSE: WHOSE RESPONSIBILITY IS IT?
| Jurisdiction | United States |
(Apr 1993)
PERFORMANCE OF THE LEASE ROYALTY CLAUSE: WHOSE RESPONSIBILITY IS IT?
Holme Roberts & Owen
Denver, Colorado
TABLE OF CONTENTS
Page
INTRODUCTION
I. COMMON LAW PRINCIPALS OF LIABILITY FOR LEASE ROYALTY OBLIGATIONS
A. The Power to Assign
B. Effect of a Complete Assignment
1. Continuing Liability of the Assignor
2. Liability of the Assignee
C. The Partial Assignment
1. Continued Liability of the Assignor
2. Liability of the Assignee
3. Effect of Contribution as Among Co-Owners of the Leasehold
4. Effect of a Sublease
II. STATE PAYOR STATUTES
A. Background
B. An Example: The Colorado Payor Statute
C. Examples From Other States
1. North Dakota
2. Montana
3. New Mexico
4. Wyoming
5. Utah
6. Texas
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7. Oklahoma
D. Constitutional Concerns
III. CONCLUSION
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Many oil and gas producers operate under the mistaken belief that the obligation to pay royalties rests solely with the person who owns the production to which the royalties in question relate. There are reasons for this belief — the "he who benefitted must pay" rule of liability is appealing in its simplicity and inherent fairness. Unfortunately for the unwary producer, things are a bit more complicated.
Three primary factors will interact to determine the answer to the question "Who is liable to the lessor for royalties?": (1) the common law relationship between the parties, if any; (2) the contractual relationship between the parties, if any; and (3) the obligations of the parties imposed by statute. Part I of this paper is an overview of the common law of landlord/tenant as it has been adapted in the unique arena of oil and gas leasing and, in particular, to the issue of direct liability to the lessor for the payment of royalties. Where relevant, Part I also discusses the contractual factor; certain lease provisions commonly employed to reach a result contrary to what the common law would dictate. In Part II of the paper I will discuss, in general terms, some of the statutory law that has recently evolved to create so-called "payor" liability and the relationship of these statutes to the common law.
PART I: COMMON LAW PRINCIPALS OF LIABILITY FOR LEASE ROYALTY OBLIGATIONS
Beginning with a discussion of the common law is important because the common law is the baseline from which the legal relationships between the oil and gas lessor and lessee are logically analyzed. It is also desirable to have a general understanding of common law principles in order to see how the common law may be changed by statute or contract and because courts continue to draw upon the common law when interpreting those statutes and contracts.
Most of the common law principals we will discuss have evolved in the context of commercial real estate leasing. Courts have indicated a willingness to depart from commercial real estate leasing principles, however, where necessary to
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accommodate the particular needs of oil and gas mineral leasing. These departures will be noted.
A. The Power to Assign
In the typical landlord-tenant relationship, the landlord often restricts the tenant's power to assign or sublease the leasehold.1 The landlord may prohibit the tenant from assigning or subletting altogether, or may permit tenant transfers but only with the landlord's consent.2 In the oil and gas lease context, however, the opposite is usually the case; the lessor typically does not restrict the lessee's power to assign. Oil and gas leases generally contain language expressly authorizing assignment either in whole or in part.3
B. Effect of a Complete Assignment
A lease is at once a contract and a grant of a leasehold interest in real property, thus giving rise to a
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legal relationship between the lessor and lessee that is grounded in both privity of contract and privity of estate.4
Assuming there are no contrary restrictions in the lease, either party may assign all or part of his leasehold interest. A grantee of the lessor's reversionary interest receives the premises subject to the rights of tenants under prior valid leases. Once the lessor transfers his interest, the lessor is no longer in privity of estate with the lessee although he is still in privity of contract (unless the lessee agrees to a release). The benefits of the contract, however, go to the lessor's grantee, including the right to receive unaccrued rents because unaccrued rents are an incorporeal hereditament that follow the land unless separated by agreement.5
1. Continuing Liability of the Assignor
Once the lessee has assigned his entire leasehold, he no longer remains in privity of estate with the lessor. Absent express lease provisions to the contrary or subsequent discharge by the lessor, however, the lessee/assignor remains in privity of contract with the lessor and for this reason, the original lessee continues to be liable to the lessor for royalties accruing after the assignment and for other covenants.6 The original lessee, in essence, guarantees the
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performance of his immediate assignee as well as any subsequent assignee. This rule of continuing liability is again based on the common law principle that a party's liability under a contract continues unless the other party to the contract agrees to a release.7 Oil and gas lease language releasing the assignee from prospective liability as to the interest assigned is common.8 Because such lease language is common, there will be few occasions for the courts to interpret or apply the common law rule in the oil and gas royalty context.
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2. Liability of the Assignee
Just as assignment of the lease does not destroy privity of contract between the lessor and assignor, it does not create privity of contract between the lessor and the assignee. Privity of estate is created, however, and by virtue of that privity the assignee is liable to the lessor for covenants running with the land for the period that the privity exists. The obligation to pay royalties is just such a covenant and, therefore, the assignee is liable to the lessor for royalties accruing during the period that the assignee remains in privity of estate with the lessor.9 But, because the liability is based on privity of estate, the assignee is not liable for royalties accruing before the privity of estate attaches or after it terminates.10
The assignee may contract to alter this common law rule. For example, an assignee may agree in the assignment to assume all obligations under the lease, including obligations accruing prior to the assignment. An assignee should be careful in this regard not to assume such accrued liabilities inadvertently.11
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C. The Partial Assignment
1. Continued Liability of the Assignor
The common law rule that the lessee/assignor remains liable to the lessor absent discharge is not changed by the fact of a partial assignment. As stated previously, however, the typical oil and gas lease currently in use provides for discharge of the assignor. While lease language discharging the assignor from subsequent liability with respect to the interest assigned may present difficulties of interpretation when the covenant is essentially operational (such as an express or implied covenant to develop), it is comparatively easy to apply to the covenant to pay royalties. To the extent the royalties accrue after the assignment and are attributable to production from the interest assigned, the assignor should be discharged from liability to the lessor for their payment.
2. Liability of the Assignee
The common law rule pertaining to the liability of the assignee for royalties also applies in the event of a partial assignment. A partial interest in the lease places the assignee in privity of estate with the lessor only as to that portion of the estate so assigned. Privity of estate cannot give rise to a liability greater than the "estate" to which the privity relates and, thus, the assignee is liable only for royalties accruing with respect to his interest during the period he holds that interest.12
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This rule of law is long-standing and was recognized in the early case of Bancroft v. Vizard, 202 Ala. 618, 81 So. 560 (1919), in which the lessor sought to recover all unpaid rents on a commercial real estate lease from the assignee of an undivided 50-percent interest in the lease. In holding the assignee to be liable only for his proportionate share of the rents, the court stated:
As there is no privity of contract between the lessor and the assignee of the lease, the latter is personally responsible only as a privy in estate, or in respect to covenants running with the land, while he enjoys, or has the right to enjoy, the premises, or some part thereof, as an assignee of the lease. And as he is liable by virtue of his privity, it would seem that he should be liable only in proportion to it.
81 So. at 563.
The lessor in Bancroft also argued that the assignee was jointly and severally liable with his assignor for the lease rentals because the leased premises were being used by the assignor and the assignee in a joint enterprise described in the purchase agreement between the assignor and assignee as a "partnership". The court first distinguished the covenant to pay rents from operational covenants, such as the covenant to make repairs, and then dismissed the theory of joint and several liability stating that:
[I]f several persons hold the entire interest of the original lessee of premises, not as joint purchasers, but by separate deeds or assignments, each of them having an undivided interest, they are not jointly liable to the lessor for the whole rent, but each assignee is severally liable for a part only, according to his interest in the premises as compared with the whole interest under the lease.
81 So...
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