CHAPTER 5 NON-TRADITIONAL LEASE TERMS AND HOW AND WHEN TO USE LEASE RATIFICATIONS - UPDATED

JurisdictionUnited States
Advanced Landman's Institute (Nov 2019)

CHAPTER 5
NON-TRADITIONAL LEASE TERMS AND HOW AND WHEN TO USE LEASE RATIFICATIONS - UPDATED

Deana A. Allen
Beatty & Wozniak, P.C.
Denver, CO

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DEANA A. ALLEN is Senior Counsel at Beatty & Wozniak, P.C., in Denver, Colorado, where she practices in the firm's Oil & Gas Title and Transactional Groups. She is licensed to practice in Texas, Colorado, and North Dakota. Her practice is devoted exclusively to the oil and gas industry, including rendering drilling, division order, leasehold and acquisition title opinions and representing clients in all phases of acquisition and divestiture transactions. Previously, she served as Associate General Counsel for a wholly owned subsidiary of a Fortune 250 company in Dallas where her practice encompassed issues related to real property law, title issues, regulatory compliance and transactional work. She also speaks to legal and industry groups on oil and gas topics and issues affecting the oil and gas industry. Deana graduated from the University of Kansas Business School with a M.B.A. and the University of Kansas Law School with her J.D. She is currently a member of the Oil, Gas and Energy Resources, Real Property, and Probate and Trust Law Sections of the State Bar of Texas, the Natural Resources & Energy Law Section of the Colorado Bar Association, the Rocky Mountain Mineral Law Foundation, the Denver Association of Oil and Gas Title Attorneys, and the Denver Association of Petroleum Landmen.

Table of Contents

I. INTRODUCTION

II. TOP LEASING

A. DEFINITION AND VALIDITY
B. TYPES OF TOP LEASES
C. POTENTIAL PITFALLS AND HOW TO AVOID THEM
1. AVOIDING CLAIMS OF NOVATION
2. AVOIDING CLAIMS OF CLOUD ON TITLE, SLANDER OF TITLE AND OBSTRUCTION
3. AVOIDING CLAIMS OF LIFE AFTER DEATH (REVIVOR)
D. DETERMINING WHEN THE TOP LEASE IS EFFECTIVE
1. HABENDUM CLAUSE
2. LEASE TERMINATION CLAUSES
3. RECORDING REQUIREMENTS
4. CALCULATION OF TIME
E. ENFORCING THE TOP LEASE

III. THE RULE AGAINST PERPETUITIES

A. THE RULE
B. APPLICATION TO TOP LEASES
C. APPLICATION TO ANTI-WASHOUT PROVISIONS

IV. OPTIONS AND PREFERENTIAL RIGHTS

A. EXERCISING THE RIGHT
B. NOTICE TO THIRD PARTIES
C. DRAFTING CONSIDERATIONS
1. OPTION TO "RENEW" OR "EXTEND"
2. NOTICE
3. TIMING
4. EXAMPLES

V. LEASING ISSUES INVOLVING LIFE ESTATES AND TERM INTERESTS

A. LIFE ESTATES
B. TERM INTERESTS

VI. RATIFICATIONS

VII. CONCLUSION

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I. INTRODUCTION

The oil and gas lease has been around since the first commercial well was drilled in 1859 near Titusville, Pennsylvania. A lease frequently cited as the first oil and gas lease consisted of less than one hundred words and was executed in 1853. The lease provided as follows:

Agreed, this fourth day of July, A.D. 1853, with J. D. Angier, of Cherrytree township, in the County of Venango, Pa., that he shall repair up and keep in order, the old oil spring on land in said Cherrytree township, or dig and make new springs, and the expenses to be deducted out of the proceeds of the oil, and the balance, if any to be equally divided, the one-half to J. D. Angier and the other half to Brewer, Watson & Co., for the full term of five years from this date. If profitable. 1

Needless to say, the oil and gas industry has come a long way since 1853. As the industry has evolved, so has the complexity of issues related to oil and gas leasing. There is no "standard" oil and gas lease form. The ubiquitous "Producers 88" is now available in a myriad of different forms, and larger or more sophisticated mineral owners often utilize their own unique forms. In addition, a single mineral tract may involve dozens, if not hundreds, of fractional mineral owners.

As a result, the leasing of oil and gas interests often involves complex and unique issues. The purpose of this article is to address some of those issues, specifically top leasing and the application of the Rule Against Perpetuities, options, and leasing nonperpetual mineral interest owners. This article will also discuss the proper use of ratifications and the calculation of days in a lease term.

II. TOP LEASING

After years of skyrocketing growth and leasing activity by operators, the practice of top leasing has become more commonplace as unleased oil and gas interests in competitive plays become increasingly scarce. Top leasing is a strategy employed by operators to gain a foothold in a prospect by placing themselves "next in line" upon the expiration of a particular bottom lease.

Virtually all modern oil and gas leases have a primary term, often five years or less, and a secondary term providing for the further extension of the lease. In instances where those leases are not held by production or otherwise extended into their secondary terms, operators may be reviewing top leasing opportunities as a mechanism by which to obtain a competitive position.

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A. DEFINITION AND VALIDITY

Typically, an oil and gas lease is executed by a mineral owner covering an unleased interest. A top lease, however, necessarily involves an existing lease, generally referred to as the "bottom lease."

Various definitions for a "top lease" exist, including "an oil and gas lease covering a mineral estate that is currently under a valid, existing oil and gas lease."2 Another definition for a top lease recognizes the intended effective date of the top lease, defining a top lease as "a lease granted by a landowner, during the existence of a recorded mineral lease, which is to become effective if and when the existing lease expires or is terminated."3

Courts have generally accepted the validity of a properly drafted top lease. In Mitchell v. Mesa Petroleum Company,4 the Texas Supreme Court acknowledged that "[i]f properly executed, the second lease, normally called a 'top lease,' is a valid and effective lease . . . ."5 Likewise, in Rorex v. Karcher,6 the Oklahoma Supreme Court recognized the validity of a top lease when taken subject to the rights of the bottom lessee.

Finally, in Nantt v. Puckett Energy Co.,7 the North Dakota Supreme Court noted that "[w]hile it was once thought that 'topleasing has the same invidious characteristics as claim jumping', 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."8

B. TYPES OF TOP LEASES

Top leases are generally classified as either a "two-party" top lease or a "three-party" top lease. A two-party top lease is executed between the original lessor and original lessee of the bottom lease, or the successor in interest of either party.9 An example of a two-party top lease is as follows:

A leases his mineral interest to B for a three-year primary term commencing January 1, 2012. On December 1, 2014, while the first lease to B is still in effect, A executes another lease in favor of B covering the same mineral interest.

A three-party top lease is executed between the lessor of an existing lease and a third party.10 An example of a three-party top lease is as follows:

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A leases his mineral interest to B for a three-year primary term commencing January 1, 2012. On December 1, 2014, while B's lease is still in effect, A executes a lease in favor of C covering the same mineral interest.

Top leases can further be categorized by the time at which they were obtained. A top lease may be obtained during the primary term of a bottom lease by a party anticipating that such lease will terminate at the expiration of its primary term. Alternatively, and perhaps less frequently, a top lease may be obtained by a third-party lessee during the secondary term of the bottom lease, anticipating that the bottom lease will terminate for failure to meet one of the lease's stated conditions.

C. POTENTIAL PITFALLS AND HOW TO AVOID THEM

Numerous legal issues surround top leases and generally involve disputes between the lessor, bottom lessee and top lessee. A party may claim that a top lease is invalid because it violates the Rule Against Perpetuities.11 In addition, a two-party top lease may give rise to claims of novation while a three-party top lease may give rise to claims of tortious interference with contract, cloud on title, obstruction, slander of title, maintenance and champerty,12 and revivor. Several of these claims are discussed below, along with drafting strategies designed to avoid them.

1. AVOIDING CLAIMS OF NOVATION

Texas courts have described novation as "the substitution of a new obligation, between the same parties, with the intention to extinguish the old one."13 Some commentators have argued against the application of novation, a contract principle, to oil and gas leases, a conveyance of real property rights.14 Nevertheless, courts have applied the doctrine of novation to the practice of top leasing, and such rulings have focused on the parties' intent.

A claim of novation arising in the context of a two-party top lease can be illustrated by the following example:

On February 1, 2012, Colonel Edwin Drake, Jr. leases his interest to Titusville Oil (the "2012 Lease"). The 2012 Lease is a paid-up lease containing a three-year primary term and providing for a 15% royalty. As the expiration of the 2012 Lease approaches, Titusville Oil has been unable to secure a drilling rig and approaches the Colonel about executing another lease. On June 30, 2014, the Colonel executes

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another lease to Titusville Oil covering the same interest, but providing for a 3/16ths royalty (the "2014 Lease"). In January 2015, drilling rigs have inexplicably become available and Titusville Oil commences operations for the drilling of a well and obtains production in paying quantities from the leased lands.

Because the 2012 Lease and 2014 Lease contain different royalty provisions, Titusville Oil will likely assert the 2012 Lease is the effective lease and the 2014 Lease was taken as a protective lease only. Conversely, Colonel will...

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