CHAPTER 6 DIVISION ORDER ISSUES IN THE 1990s: STATE POLICING OF AN UNRESPONSIVE INDUSTRY
| Jurisdiction | United States |
(Apr 1993)
DIVISION ORDER ISSUES IN THE 1990s: STATE POLICING OF AN UNRESPONSIVE INDUSTRY
Van Cott, Bagley, Cornwall & McCarthy
Salt Lake City, Utah
§ 6.01 Introduction
§ 6.02 Legal Doctrines, Theoretical Underpinnings, and Judicial Analyses.
[1] Legal Doctrines and Theoretical Underpinnings
[a] Nature of Title to Production
[b] Royalty Clauses
[2] Judicial Analyses: What Division Orders Are, and Are Not.
[a] Conveyance Analysis
[i] Severed Minerals
[ii] Mineral or Leasehold Estate
[b] Contract Analysis
[i] Common Law Contracts
[ii] Sale of Goods under the Uniform Commercial Code
[c] Stipulation Analysis
[d] Accord and Satisfaction Analysis
[e] Ratification Analysis
[f] Estoppel Analysis
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§ 6.03 Division Order Provisions
[1] Purchaser's Name and Address
[2] Effective Date, Time, and Duration
[3] Property, Lease, and Unit Name
[4] Warranty Clause
[a] Mispayments
[b] Conversion
[5] Change-in-Ownership Clause
[6] Proof-of-Title Provisions.
[7] Ratification of Underlying Lease or Purchase Agreement
[8] Purchase and Sale Terms (Details of Payment Timing and Mechanics)
[9] Division of Interest
[10] Owner's Name, Address, and Tax Identification Number
[11] Signatures
[12] State Preemption
§ 6.04 Industry Standards, Usage, and Customs
[1] Execution of a Division Orders as a Pre-Requisite to Payment
[2] No Interest on Suspended Sums
[3] No Division Order Transmitted Until Probability of Ownership Determined
[4] No Division Order Requested for Infill Wells
[5] Division Orders as Conveyances
[6] Division Orders as Lease Amendment Tools
[7] Division Orders as Curative Instruments
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[8] Recouping Overpayments.
[9] Suspense Accounts
[10] Lessee's Obligation to Pay
[11] Gas Rate Increases (FERC) and Other Contingent Rights
[a] Rate Increases
[b] Contract Price v. FERC Price
[c] Gas Not Sold at Well
[12] Types of Division Orders
[13] Transfer Order
§ 6.05 Remedial Legislation Affecting Division Orders
[1] Division Orders Defined
[2] Division Order Contents
[3] Division Orders as Amendatory Instruments
[4] Effect of Fully Executed Division Order
[5] Interest on Suspended Sums
[6] Modification of Statutory Terms by Agreement of Parties
[7] Cancellation of Lease for Failure to Pay
[8] First Purchaser/Lessee Exemption from Statutory Mandates
[9] Statutory Declaration: Lease is Essence of Obligation to Pay
§ 6.06 Recommendations
[1] Lease Changes
[a] Royalty/Rental Payment Clause
[b] Royalty Clauses
[c] Change-in-Ownership Clauses
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[2] Division Orders
[a] Unmarketability of Payee's Title
[b] Land Descriptions
[c] Ratification Language
[d] Terminability
[e] Signatures
§ 6.07 Conclusion
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There was a little girl and she had a little curl
Right in the middle of her forehead.
When she was good,
She was very, very good,
But when she was bad, she was horrid.
Anonymous 1
§ 6.01 INTRODUCTION
Regrettably, the rhyme aptly describes modern division order practices. "When [we] are good, we are very, very good. But when [we] are bad, [we] are horrid."
Like any behavior, the few spoil it for the many. Because of the few, states have launched a disciplinary campaign of payment management statutes. Majors blame independents. Independents blame majors. But there is sufficient blame to share. Majors have the human and technological resources to better monitor payment obligations and to give their payment practices quality control. Yet, frequently they do not. Inquiries go unanswered; demands, justified or not, are ignored. Independents are often unresponsive because they lack the resources to timely respond or are unaware of the consequences of failing to respond. Both majors and independents have allowed themselves to be lulled into a false security that their division order practices are impeccable.
Regardless of who is to blame, industry division order practices are shoddy at best. Division order analysts are plagued with the problems. Outside counsel augment their retirement funds.
One would think that with the myriad articles addressing division orders and division order practices, the message that industry needed to clean-up its act should have registered.2 Apparently it has not. In all fairness, the courts have contributed to the problem. Jurists have focused on results, rather than legal theories to decide disputes. The product is a hodgepodge of judicial rambling without guidance to the industry.3 One astute practitioner observed that little guidance may be taken from the plethora of commentary and decisional law, as "division order cases comprise the "Am. Jur." of oil and gas law."4
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Division orders and division order disputes continue to constitute a major segment of oil and gas litigation in courts and before administrative tribunals.5 Moreover, recent articles, taking a decidedly pro-royalty owner tack, have been less than helpful in streamlining division order practices. Some advocate the elimination of the division order altogether.6
This article makes the case for division orders, based upon sound legal theories, and for quality-controlled, modernized division order practices. Division orders represent an indispensable tool in the commercial relationship between the purchaser and the owner of the severed minerals. The article addresses the legal (theoretical) underpinnings supporting the continued use of division orders; their contents, purposes, and uses; restrictions imposed by remedial legislation; the effect of FERC rulings on division order practices; and recommendations to avoid statutory and common law pitfalls. This article does not address apportionment issues, take-or-pay problems, or suspense account practices except as suspense account practices pertain to statutory requirements to sign or not to sign division orders as pre-requisites to payment. Suspense accounts are discussed in the existing literature.7
§ 6.02 LEGAL DOCTRINES, THEORETICAL UNDERPINNINGS, AND JUDICIAL ANALYSES.
Authorities can shed little light on the origins of division orders. One classicist quipped that division orders "appeared full grown [as] from the head of Zeus."8 Another, more academically inclined (at least on the subject of origins), concluded, a fortiori, that their use developed in the oil patch during the late 1890's as an accounting tool for distribution of revenues and promptly became the subject of litigation.9
This was an ominous sign, indeed. So far as can be documented, "division orders" first found themselves the subject of academic treatment in 1925, not surprisingly under the subheading, "Damages for failure to deliver lessor his share."10 Their current form and use varies little from those first beginnings.
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[1] Legal Doctrines and Theoretical Underpinnings. 11
Two legal theories provide the underpinnings of division order law. The first is the nature of title to production. The nature of the title is determined by property law. The second is the royalty language employed by the parties to an oil and gas lease. Royalty clauses determine when title vests. Both theories invoke common law, and in some cases, statutory elements of contracts and the sale of goods.
[a] Nature of Title to Production.
The disposition and sale of severed oil and gas is governed by personal property law12 in all states. This is the case irrespective of legal doctrines espoused to characterize the ownerships of minerals prior to capture or severance from the earth.
Title to oil taken in kind under a lease typically remains in the lessor.13 When the lessor fails to provide storage facilities or pipeline connections, he has been held by the courts to have marketed his in-kind royalty oil through his lessee. The royalty oil is delivered to the tanks or pipelines to the lessor's credit.14 In either event, title to the severed oil remains in the lessor by operation of the reservation in the royalty clause of the lease.15
Title to gas, on the other hand vests in the lessee either by execution of the lease or by reduction of the severed gas to possession at the wellhead. Whether title vests by execution of the lease or at the wellhead depends on the ownership theory for fugacious minerals applied by the law of the jurisdiction.16
Title to oil not taken in kind passes to the first purchaser17 under a division order upon delivery by the lessee to the pipeline or tanks. Again, delivery in this instance
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is to the credit of the lessor.18 Title to gas and its associated constituents passes to the first purchaser under the purchase contract at the designated point of delivery.19 With the passage of title, a monetary liability accrues on the part of the first purchaser to the owners of the interest.20
[b] Royalty Clauses. Oil and gas royalty clauses determine the point at which title to production vests in the producer or in the first purchaser.
Oil royalty clauses commonly utilized in most oil and gas producing states, including the Rocky Mountain West, authorize the lessor, at his option, to take in kind a fractional share or percentage of all oil produced and saved, or to have the royalty oil delivered to the pipeline or storage tanks to the credit of the lessor.21 Under such clauses, title to the royalty oil remains in the lessor by operation of the royalty reservation.
The lessor may exercise his option to take royalty oil in kind by one of two methods. He may express his election by notifying the lessee in writing to take in kind, or he may imply his election by installing tanks or other storage facilities.22 If the lessor does not opt to take in kind, then the lessee has not only the...
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