CHAPTER 7 TITLE DEFECT PROCEDURE

• Jurisdiction: United States

Oil & Gas Agreements: Purchase & Sale Agreements
(May 2016)
CHAPTER 7
TITLE DEFECT PROCEDURE
Steven B. Richardson
Partner
Bryan Cave LLP
Denver, CO

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STEVEN B. RICHARDSON is a partner in the Denver office of Bryan Cave LLP in its Energy and Natural Resources Client Service Group. He represents a wide range of oil and gas, mining, and power companies, financial institutions, and investors in energy and natural resource transactions and projects, including mergers and acquisitions, partnership formation, private equity investments and financial institution investments in oil and natural gas exploration, development, production, gathering, transportation, processing and marketing, throughout the U.S. Such work includes exploration and development agreements, joint ventures, participation agreements, operating agreements, gas gathering, processing and marketing agreements, production payments, leasing, surface use agreements and other project development, financing, and operational arrangements involving oil and gas projects on fee, federal, state, and Indian lands. He is also active in project development, acquisition, financing, tax equity, and operations for renewable and conventional power projects including wind, solar, biomass, geothermal, and landfill projects, natural gas generation projects, biodiesel, ethanol and other alternative fuels projects, including site acquisition, power purchase, interconnection, and transmission agreements, construction contracts, warranty agreements, feedstock supply agreements, operating and maintenance agreements, and financing arrangements. He received his B.A., magna cum laude, in physics and mathematics from the University of Colorado in 1978 and his J.D., cum laude, from Harvard Law School in 1981. He is admitted to practice in Colorado. He is a past Trustee of the Rocky Mountain Mineral Law Foundation and has written numerous papers for Rocky Mountain Mineral Law Foundation institutes. He is a frequent speaker on oil and gas and energy topics, and is a former adjoint professor in the Graduate Energy Management Program at the University of Colorado Business School, Denver campus.

Chapter 30 TITLE ASPECTS OF PURCHASE AND SALE AGREEMENTS: DEFECTS, ADJUSTMENT MECHANISMS, AND REMEDIES

Synopsis

§ 30.01 Introduction

§ 30.02 Purpose and Deal Process Dynamics

[1] Purpose and Background

[2] Deal Process

§ 30.03 Details of the Title Provisions

[1] What Is a Title Defect?

[a] Title Opinions--Marketable Title Standard

[b] Purchase Agreement Defensible Title Standard

[i] Elements of Purchase Agreement Definition of Defensible Title

[ii] Defensible Title Definition for Undeveloped Leases Based on Net Mineral Acres

[c] Other Issues

[i] Value Concentrated in Target Formations

[ii] Remaining Primary Term

[iii] Unusual Terms in Leases or Material Agreements

[2] Permitted Encumbrances

[a] Sale Process Identification of Property-Specific Permitted Encumbrances

[b] Discussion of Certain Permitted Encumbrances

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[i] Common Permitted Encumbrances

[ii] Less Common Permitted Encumbrances

[3] Defect Notice Mechanics

[a] Defect Notice Deadline--Pre- or Post-Closing

[b] Mechanics of Notice of Title Defects

[4] Title Defect Value

[a] Liquidated Amounts

[b] Linear Defects--Same Proportionate Impact on Working Interest and Net Revenue Interest

[c] Non-Linear Defects--Disproportionate Impact on Working Interest and Net Revenue Interest

[d] Other Defects

[e] Defects Affecting Producing Wells and Undeveloped Leases

[5] Thresholds and Deductibles

[a] Thresholds

[b] Deductibles

[6] Interest Additions

[7] Procedures for Handling Title Defects

[a] Mutual Agreement

[b] Right to Exclude Property

[8] Title Dispute Resolution Procedures

§ 30.04 Title-Related Conditions to Closing

§ 30.05 Post-Closing Title Curative Rights

§ 30.06 Special Warranty in Conveyance and Relation to Title Defect Procedures

§ 30.07 Other Matters Often Handled with Title Matters

§ 30.08 Special Situations

[1] Exchanges

[2] Multiple Sellers or Multiple Buyers

§ 30.09 Conclusion

§ 30.01 Introduction^*

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Title defect provisions are among the most intensely negotiated aspects of purchase and sale agreements ("purchase agreement") and exchange agreements for oil and gas properties. There are numerous ways to approach handling title defects beyond the obvious desire of the seller to complete the deal with minimal title adjustments and the buyers desire to have the right to such adjustments if it discovers title issues. The approach depends in part on the type, size, and complexity of the transaction involved and on the buyers post-closing development plans for the properties. This chapter discusses the issues that typically arise in negotiating title defect provisions in purchase agreements.

§30.02 Purpose and Deal Process Dynamics

[1] Purpose and Background

The obvious purpose of title defect provisions in a purchase agreement is to give the buyer a mechanism to raise title defects and make appropriate purchase price adjustments if the seller does not own the interests scheduled in the sale materials on which the buyer based its determination of its offer price. In order for the sale process to go smoothly, without revisiting price later in the process, the seller should allow sufficient time to (1) prepare for the sale; (2) prepare an accurate schedule of its working interests (WI) and net revenue interests (NRI) in the subject wells and leases, including any before payout and after payout interests; and (3) verify that such schedule matches the WIs and NRIs used in preparing the reserve report, if any, used in the sale process (whether such report is prepared by the seller or by its independent petroleum engineering firm). Such schedule should be used consistently throughout the sale process. It is important for buyers team to understand where the buyer believes the value lies in the package of properties and buyer's post-closing development plans for the properties in order to focus their diligence efforts.

Today's resource play deals may include undeveloped leases covering hundreds of undeveloped drilling or spacing units for future horizontal wells based on existing, or assumed, drilling or spacing unit patterns. Frequently, such undeveloped lease value constitutes a majority of the deal value. In these deals, the usual historical focus on title to the producing properties as the majority of value is reversed with the focus being on the undeveloped locations. The buyer's title review is much more challenging when the buyer is faced with reviewing title to leases covering potentially

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hundreds of undeveloped locations in essentially the same amount of time that a buyer was historically expected to review title to producing properties. It is less likely that the seller's files will be complete, thorough, and orderly when the seller acquired large undeveloped lease positions either through direct leasing or a series of acquisitions of undeveloped leases from third parties based on landman reviews without any associated title opinions. These factors, coupled with short time deadlines, require that buyer conduct a well-coordinated title diligence process.¹

[2] Deal Process

Larger transactions often involve a solicitation of bids from multiple qualified bidders. At some point in the process, the seller will submit a draft purchase agreement to the bidders for comment. There are different schools of thought among companies, investment bankers, and lawyers on when to furnish a draft purchase agreement in the sale process. From the seller's standpoint it is desirable to get a "full" markup of the purchase agreement from the potential buyers that remain in the process when it is down to the short list. From the markups the seller may be able to identify material issues or showstoppers in time to be able to move on to the next best bid without signaling to the next best bid that the seller's first choice has fallen through. The seller may choose to commence detailed negotiation of the purchase agreement with two or more bidders to have an alternative if it is unable to agree on a purchase agreement with its first choice bidder. Smaller transactions do not have to be conducted through the sale process as described above, but can be based on a letter of intent with just the basic terms (e.g., price, properties, effective date, closing target date).

§ 30.03 Details of the Title Provisions

Once a transaction is at the point of negotiating the purchase agreement, the details of the title provisions will need to be addressed. The title provisions in a purchase agreement for a large transaction including dispute resolution provisions can be complex and run many pages.²

[1] What Is a Title Defect?

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[a] Title Opinions--Marketable Title Standard

Various title standards are used for different purposes in the oil and gas industry. For a title opinion, a title attorney applies a "marketable title" standard as the baseline to identify defects that would cause title not to be marketable title.³ Defects, liens, encumbrances, burdens, and other defects or irregularities that impair marketable title are identified in the opinion, including the actions required to cure the defect. The marketable title standard being applied by the title examiner is a high standard. These requirements can be voluminous, especially for opinions covering large spacing units for horizontal wells that may include dozens of oil and gas leases. Although some of the requirements may seem overly technical, the oil and gas company obtaining the opinion must evaluate them and determine whether to attempt to cure or waive the defect. The assessment of whether to waive the defect depends on the purpose for which the opinion was obtained, whether...