CHAPTER 4 THE ETHICS OF TOP LEASING

• Jurisdiction: United States

Implied Covenants
(Nov 1986)
CHAPTER 4
THE ETHICS OF TOP LEASING
HUGH C. GARNER ^*
Attorney at Law
Salt Lake City, Utah

In the lexicon of the law of oil and gas, what, precisely, is a top lease? Essentially, it is a subsequent oil and gas lease covering one or more mineral interests which are already subject to a valid subsisting oil and gas lease.¹ Thus, the top lease sits on top of the existing lease; the first or existing lease is the "bottom lease".²

If we could leave top leasing there, in its pristine simplicity, all would be well. But factual variables can slither into our path, like the serpent in the garden, to bring disharmony into this legal Eden. Consequently, for pure, unadulterated emotionalism few subjects in the field of oil and gas law can exceed the drang und sturm conjured up by a discussion of "top leasing". Courts need not have top leasing as an issue to inveigh against the practice. In one case, the

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appellee complained that the conduct of the appellant was designed to eliminate appellee's interest so that the appellant could top lease.³ There was no top lease involved, only an imagined threat of what might have been, yet the court rose to the occasion and in a footnote proceeded to define a top lease and then, in condemnatory tones, excoriate "[t]op leasing [as having] the same invidious characteristics as claim jumping."⁴ And in the Old West nothing was as despicable as a claim jumper. Strong language, indeed.

However, coming full circle, in a recent case, another court conceded that "top leasing has become a useful and widespread business practice in the oil and gas industry in North Dakota, as well as in other regions."⁵

The irony is that top leasing has been with us for a long time. In a case decided 60 years ago the Oklahoma Supreme Court tussled with this problem without once using the term "top lease".⁶ There, James Moyer, as lessor, granted a lease to

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Gypsy Oil Co. (on November 25, 1919) for a term of five years ending December 15, 1922 "and as long thereafter as oil or gas, or either of them, is produced" from said land. On November 10, 1922, just 35 days before the end of the primary term of the first lease, William Moyer, then owner of the property, granted Marsh a lease for a term of five years from January 2, 1923 and as long thereafter as oil or gas or either of them is produced therefrom by the lessee. Gypsy spudded a well on the leased premises on December 2, 1922 and completed it on December 12, 1922, three days before its lease expired, at a depth of 1,060 feet, in a sand which produced a small quantity of oil. Gypsy put up a storage tank and ran a line three and one half miles to the facilities of a local buyer who paid the munificent sum of 50 cents per barrel to Gypsy and Moyer. Payment was made in accordance with the division order signed by Gypsy and Moyer on December 19, 1922. The court noted that both Moyer and Marsh entered into the lease of November 10, 1922 with full knowledge of the outstanding lease to Gypsy: $3,500.00 was the consideration which Marsh paid on December 23, 1922 upon delivery of the lease. Marsh gave notice to Gypsy that the well was not within the meaning of the lease and that it (Gypsy) was to vacate the premises.

Using as its starting point that "produced" means substantially the same thing as "produced in paying quantities" the court did some bookkeeping and decided that the cost of operations exceeded income. Gypsy was paying $5.00 to produce

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$4.60 in income. The court concluded that Gypsy's claim that it had made a discovery of oil in paying quantities was not made in good faith. The court made short shrift of the contention that Moyer was estopped to deny the validity of the lease in that he had signed a division order with Gypsy, noting that the order was signed before any oil was run from the well and at a time when Moyer had no facts as to the nature and amount of production. In affirming the lower court's holding for Marsh, the court bottomed its decision on equitable considerations involving the rights of parties under their respective leases and without any of the emotional moral overtones of top leasing. If there were a smudge of unclean hands, it was on the oil company's towel; it was the company that "was conversant with the facts, and knew that it had not discovered oil in paying quantities at the time of the execution of the division order."⁷

Generally, the courts have held top leases to be valid. The Oklahoma Supreme Court, in a 1923 case, admitted that it could find no authority to support the defendants contention that the plaintiff's top lease was void and said:

The lessors were the owners of the fee-simple title to the property, and the same was not restricted in any manner whatever. Such being the condition of the title, there was no reason why the owners of the fee could not carve out as many estates as they saw fit. There was no reason why the [lessors] could

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not execute a second oil and gas lease during the existence of the first lease. Of course, the holders of the second lease would take same subject to the rights of the holders of the first lease...we are therefore of the opinion that the lease to the plaintiff was valid and the judgment should have been rendered for the plaintiff.⁸

So, in spite of the readings between-the-lines, the innuendo and invective, what we have is a business practice which, at its inception, might have been characterized as being "sharp", but in the shakedown does not appear to be legally or morally wrong.

Perhaps we should not be looking at this within the broad meaning of ethics, but rather, in the more limited sense of legal ethics, i.e. that branch of moral science which treats of the duties which a member of our profession owes to the public, to his professional brethren, and to his client.⁹

If we use this as our springboard we can jump into the specifics of top leasing and some of the legal ramifications, whether we represent a client who is contemplating top leasing or we are advising him how to protect his possessory rights against a subsequent lease.

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In the economic environment of the moment, top leasing is assuming proportions of great importance. We are seeing instances where the lessee is financially strapped or unwilling to proceed with a drilling program. And, as is so often the case, there is always another party waiting in the wings, well aware of the lessee's precarious finances or his management's reluctance to spend money, and who is a perfect candidate to be a top leaser. It is almost a surety that, as oil prices revive and the industry reasserts itself after a depressed hiatus of several years, there will be many leases which are not in production and nearing the end of their primary terms. Here are the makings of a happy hunting ground for the aggressive entrepreneur.

There are a number of sub-species within the genus of top leases. One, for instance, involves a situation where landowner L leases to lessee B for a primary term ending October 1, 1986. While this lease is in effect L grants a lease to lessee C on August 15, 1986 with a primary term to begin upon the expiration of the bottom lease. (This is a "two-party" top lease; we will call this situation A). The next case involves a lease granted by...