CHAPTER 8 KEEPING OIL AND GAS LEASES ALIVE A REVIEW OF BOTH THE MINERAL LESSEE'S OBLIGATIONS AND POSSIBLE WAYS TO KEEP LEASES IN EFFECT

• Jurisdiction: United States

Problems and Opportunities During Hard Times in the Minerals Industry
(May 1986)
CHAPTER 8
KEEPING OIL AND GAS LEASES ALIVE A REVIEW OF BOTH THE MINERAL LESSEE'S OBLIGATIONS AND POSSIBLE WAYS TO KEEP LEASES IN EFFECT
William P. Pearce
Pearce & Durick
Bismarck, North Dakota

INTRODUCTION

An oil and gas lease in some ways resembles a newborn baby. It comes into the world amid great hope and promise but a certain amount of nurturing, care and good luck is required for it to achieve a long and healthy life. This paper will focus on the kinds of care required to keep it healthy in the face of lapse of time, economic pressures and anxious lessors. The first section deals with the conceptual nature of just what it is we are trying to keep alive. The discussion will then cover the individual lease provisions and the covenants implied into oil and gas leases that pertain to maintenance of the lease. An overview of the complicated subjects of pooling and unitization, as they relate to keeping the lease alive, follows, and finally the impact of bankruptcy on lease maintenance is discussed. A detailed discussion of all of these matters is beyond the scope and limitations of this paper, but it is hoped that discussion here will provide a useful framework and synopsis of the varied elements that bear upon the health and welfare of an oil and gas lease.

NATURE OF THE OIL AND GAS LEASE

The modern oil and gas lease, rather like the duck-billed platypus, is a curious hybrid creature. It partakes of features of both real property law and contract law and, in some jurisdictions, even of personal property law.¹ There are a large number of contexts in which the question whether an oil and gas leasehold interest is real property or personal property can potentially have legal significance, such as in property taxation, lien laws, recording acts, venue provisions for legal actions, conveyancing requirements, and the like.² Despite the variety of potentially troublesome areas created by realty-personalty distinctions, however, the existence in many of the oil and gas producing states of statutes dealing specifically with oil and gas interests has significantly reduced the importance of the realty-personalty distinctions.³

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In the context of the bankruptcy laws, however, the conceptual nature of the leasehold interest can have practical legal consequences, as will be seen below, and for this reason it is helpful to discuss this question at the outset.

Before looking at how particular jurisdictions have characterized the oil and gas leasehold interest, it is instructive to consider briefly just what it is we mean by stating that a lessee has a legal "interest" or a legal "right" in "property". Prior to the execution of the lease the mineral owner has certain rights in property; he is said to "own" the minerals. Once the lease is executed and delivered, he owns some reduced rights and the lessee now "owns" some interest in the minerals. It is often stated that each has a separate and distinct property right or estate (interest) in the land.⁴ Simply to make the conclusory statement that each has a property right in the oil and gas, however, does not shed any light on their mutual rights and duties. That question can be analyzed only by looking behind the descriptive words "property" and "ownership":

"In the first place, it is necessary to distinguish between the right of ownership itself and the subject-matter of that right....It is necessary to realize, however, that although 'property' is often used in this loose way to refer either to the thing itself or to the rights in that thing, the concept of ownership itself is quite distinct from any tangible things to which it may relate, for it is no more than the expression of a legal relationship resulting from a set of legal norms.

....

For this purpose it may be said that ownership is not a single category of legal 'right' but is a complex bundle of rights whose precise character will vary from legal system to legal system."⁵

Thus "property", as a legal concept, connotes not a thing in itself but rather certain rights. These rights are not between the property owner and some thing or object, but are rights between the owner and all other persons with respect to that thing or object.⁶ This concept of the enjoyment by one person of a certain bundle of rights in a thing such as land, enforceable by the sanctions of the law against all other

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persons who might seek to assert any enjoyment of rights in the same thing, is at the heart of the common law theory of private ownership of property.⁷ As a general principle the nature of private property resides in the legally protected right of the owner to exclude others from exercising power or control over, or enjoying the fruits of, some object or thing.⁸

In the context of the oil and gas lease, therefore, the question revolves around the rights the lessee obtains under the lease to exclusive enjoyment of an interest in oil and gas. In other words, to what extent can he exclude any other person, in particular the lessor, from exercising dominion over the oil and gas in the leased tract? For the purposes of this paper, the focus of the inquiry is on how long the lessee can exclude the lessor, that is how long does the lease confer whatever rights it does upon the lessee and how can he act so as to maximize the period of continuing existence of the lease.

The discussion above presupposes that the oil and gas lease confers a property right of some sort upon the lessee. The courts have generally taken this for granted and have viewed the lease as something more than merely a contract.⁹ Though a court will often make loose statements to the effect that an oil and gas lease is a contract between the parties, what is usually meant is that the lease provisions will be construed to determine the parties' intent under the same rules as are applied to a written contract.¹⁰ The lease is usually deemed to grant an interest of some kind in land to the lessee, though it does at the same time impose certain express and implied covenants or contractual duties upon the lessee.¹¹ Whatever the oil and gas lease is, it is almost universally recognized that the term "lease" is a misnomer, in the sense that it has very little in common with ordinary leases or landlord-tenant relationships.¹²

Lease as an Interest in Land or as Personal Property

Most jurisdictions regard the oil and gas lease as creating an interest of some kind in land. Within this broad generalization several different categories of real property interests are utilized to describe an oil and gas lease. At one end of the spectrum lie Texas and several other states, which hold that an oil and gas lease grants to the lessee a determinable fee interest in the oil and gas in place.¹³ Thus the lessee obtains absolute ownership of the working interest portion of the oil and gas in place, subject only to the occurrence of the special limitation upon which the

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determinable fee interest will automatically terminate.¹⁴ The lessor's retained interest consists of two parts: the reserved royalty, which is also an interest in land¹⁵ , and a possibility of reverter as to the lessee's interest if the event occurs which causes the determinable fee interest to terminate automatically. The possibility of reverter is likewise an interest in land.¹⁶

Under Texas law, therefore, the lessee obtains the greatest interest he could possibly acquire. He owns his percentage of the oil and gas in place for as long as the lease continues in effect. Mississippi has always taken the same position as Texas, that the lessee owns a determinable fee interest in the oil and gas in place.¹⁷ For many years, this did not appear to be the case in Oklahoma, but the 1984 decision of the Oklahoma Supreme Court in Shields v. Moffitt¹⁸ appears to have established that the lessee in Oklahoma also acquires a determinable fee interest. In a more recent decision, however, Cate v. Archon Oil Co., Inc.¹⁹ , the Oklahoma court, without citing Shields, states that an oil and gas lease "creates an interest in realty although it is not per se real estate," and it may be that Oklahoma law is not exactly clear as to what kind of interest in real estate the lease creates.²⁰ New Mexico has also followed the lead of Texas in holding that an oil and gas lease vests a determinable fee interest in the lessee.²¹ In North Dakota, the lessee acquires an interest in real estate, the precise nature of which has not been clearly articulated by the North Dakota Supreme Court, but North Dakota is grouped with the determinable fee jurisdictions here, partly because the Court may have suggested that and partly perhaps because the author believes it should be so.²²

Without seeking to draw undue attention to the variations in the classification of the leasehold interest among the states, it is interesting to note the difficulties the courts have had in trying to clarify the nature of the oil and gas lease. A number of states have adopted what is sometimes referred to as the California view, that a lease does not create a possessory interest in oil and gas in place but creates merely the privilege to go upon the land to explore for and develop oil and gas, which becomes personal property when reduced to possession. This interest is in the nature of a common law "profit a prendre" and is conceived to be an "interest in land" but not a grant of an actual estate in the oil and gas in place.²³ The complexities inherent in the profit a prendre concept and whether the interest is corporeal

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or incorporeal and what consequences may flow from that distinction need not concern us here.²⁴ The important point is that the profit a prendre is deemed to be an interest or estate in real property.

Several of the Western states have adopted this theory that the oil and gas lease creates an interest in real property...