CHAPTER 9 INDUSTRY AGREEMENTS AFFECTING RECORD TITLE

• Jurisdiction: United States

Nuts & Bolts of Mineral Title Examination
(Apr 2015)
CHAPTER 9
INDUSTRY AGREEMENTS AFFECTING RECORD TITLE
Milam Randolph Pharo
Of Counsel
Sam Niebrugge
Associate
Davis Graham & Stubbs LLP
Denver, Colorado

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MILAM RANDOLPH PHARO is currently Of Counsel with Davis Graham & Stubbs in Denver, Colorado. For more than 30 years his practice has concentrated on the upstream oil and gas business, serving both in-house and in private practice. Mr. Pharo has spent many years involved with the Rocky Mountain Mineral Law Foundation, serving as the Colorado reporter for its Mineral Law Newsletter, as the Annual Institute program chair for the Landman's and Oil and Gas sections, as a member of the program committee for Special Institutes, as a trustee, and as a member of its Board of Directors. He has presented papers at various Rocky Mountain Mineral Law Foundation Annual Institutes and Special Institutes. Mr. Pharo has spoken to a number of both bar and industry associations on oil and gas matters. In 1999, the University of Denver Sturm College of Law recognized Mr. Pharo as its Distinguished Natural Resources Practitioner in Residence. He has assisted in the instruction of a number of classes at this law school and Washburn University School of Law primarily related to oil and gas contract negotiations. He earned a B.A. at the University of Texas (1974) and a J.D. from Southern Methodist University (1977).

§ 1. Introduction¹

The upstream - or exploration and production - phase of the oil and gas industry is filled with various contracts that may alter a party's interest in its leasehold ownership estate or that may pose duties or benefits on such record title interests notwithstanding their absence from the owner's chain of title. This paper will give a brief overview of at least some of these typical contracts. In particular, this Paper will discuss how the constituent parts of such contracts may affect title, even if unrecorded, and review some of the issues facing subsequent purchasers regarding whether or not they are bound by the terms of these agreements.

§ 2. Industry Agreements

[A] Operating Agreement.

The operating agreement has been defined as a contract typical to the oil and gas industry whose function is to designate an operator, describe the scope of the operator's authority, allocate costs and production among the parties to the agreement, and provide for recourse among the parties if one or more defaults in their obligations.² For purposes of this Paper, we would add that for at least the last three and one-half decades, this agreement, particularly the Model Form JOA and its various versions,³ while beyond the scope of this Paper, has been dissected and analyzed extensively in presentations for this foundation and many others.⁴

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For our purposes, we should focus on the fact that a JOA is a form of contractual working interest pooling arrangement that can vary a lessee's⁵ share of costs and production from that of the lessee's individual lease, even if a well is located on that lease.⁶ By contract, a lessee may have a variable interest before and after the recoupment of non-consent penalties.⁷ A party may be subject to a preferential right to purchase that will affect the alienability of the parry's tract.⁸ There may be other contractual duties such as an area of mutual interest ("AMI"), which we will discuss later in this Paper. There may be forfeiture provisions that trigger the divestment of one's ownership interest. There may be development obligations or restrictions on the use of one's leasehold such as a limitation on the number of wells that can be proposed in any defined time period. What is important for our purposes in this discussion is that all of these potential impacts on a party's record title ownership in its leasehold estate, i.e., its real property interest (in most states), can be caused by a document that is unrecorded in one's chain of title.

The examiner should expect that if the lands are at a stage of development where a well is anticipated, a JOA is likely to exist when multiple tracts of land are involved in

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the development project.⁹ The JOA has become the "go to" instrument for combining a variety of tracts and their attendant leasehold to provide for the orderly development of such lands. As noted above, the JOA appoints an "operator," defines many of the rights and duties as between the operator and the remaining parties (the "non-operators")/ allocates revenues and expenses, and provides a framework by which an orderly development process can occur. Except as discussed in a later portion of this Paper,¹⁰ we are not concerned with how the JOA binds the original contract parties, but rather the JOA's impact on subsequent purchasers who succeed to all or a portion of the interests of an original party, either directly or in an extended chain of title to the affected leasehold. The backbone issue of this presentation is this: Are subsequent purchasers bound by the terms of these unrecorded agreements?

Each version of the Model Form JOA contains language regarding successors and assigns. The 1989 Model Form JOA provides:

This agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, devisees, legal representatives, successors and assigns, and the terms hereof shall be deemed to run with the Leases or Interests included within the Contract Area. ¹¹

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The 1956 Model Form JOA provides:

This agreement may be signed in counterparts, and shall be binding upon the parties and upon their heirs, successors, representatives and assigns. ¹²

This intent to bind subsequent purchasers appears in the 1977 Model Form JOA:

This agreement shall be binding upon and shall inure to the benefit of the parties hereto, and to their respective heirs, devisees, legal representatives, successors and assigns. ¹³

The 1982 Model Form JOA provides:

This agreement shall be binding upon and inure to the benefit of the parties hereto and to their respective heirs, devisees, legal representatives, successors and assigns. ¹⁴

Thus, in each of the four Model Form JOAs, the drafters envisioned both assignability and continuing responsibility to the terms of the Model Form JOA on subsequent purchasers of the affected leasehold. This question of the original contracting parries' intent to bind subsequent purchasers will become important as we analyze how and why subsequent purchasers are or are not bound by the terms of unrecorded agreements, whether referenced or not. A clue to this analysis is provided by the enhanced language of the 1989 Model Form JOA, which spells out that the parties intend for the terms of the Model Form JOA to be deemed to run with the leases and the unleased lands affecting the tracts of land lying within the Contract Area covered by the Model Form JOA. This concept of running with the land will necessarily take us to an analysis of real covenants and equitable servitudes and the inquiries surrounding whether or not they are binding upon subsequent purchasers. Equally important to the assignor, we will examine one significant case where, while the terms of an operating agreement were binding on the subsequent purchaser, the assignor was not absolved from responsibility when the subsequent purchaser failed to perform.¹⁵

Before leaving JOAs, let's look at how they might alter a party's record title ownership in an oil and gas lease.¹⁶ Assuming that the lease in question covers the

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entire fee oil and gas mineral estate on a particular tract of land, this leasehold is nevertheless combined or contractually pooled with other tracts such that:

Unless changed by other provisions, all costs and liabilities occurred and operations under this agreement shall be borne and paid, and all equipment and materials acquired in operations on the Contract Area shall be owned, by the parties as their interests are set forth in Exhibit "A." In the same manner, the parties shall also own all production of all Oil and Gas from the Contract Area subject, however, to the payment of royalties and other burdens on production as described hereafter. ¹⁷

Thus, even if the well is located entirely on the mineral estate covered by an individual party's oil and gas lease, such party will not receive 100% of the production nor bear 100% of the costs for such a well.

Even if a party suffers a complete loss of title, it may not lose its contractual rights to share in the costs and revenue of a well drilled in the Contract Area. Article IV of the 1989 Model Form JOA controls title questions regarding the leases, but does not always require a recalculation of an affected party's Exhibit "A" interest based upon a failure of such party's title in a lease within the Contract Area.

Article VI of the 1989 Model Form JOA often has the most bearing on a party's record title by re-allocating production among participating and non-participating parties. This is especially true if combined with a required well provision in Article XVI, the Other Provisions section of the 1989 Model Form JOA (Article XV in the 1977 and 1982 Model Form JOAs, and in Section 31 in the 1956 Model Form JOA). In essence, these provisions govern the impact of a party's either voluntary or by operation of the provisions, involuntary, election to not participate in an operation conducted pursuant to the JOA. To reward the parties who take on the costs and risks of such an operation, the JOA provides in both of these sections for a variety of remedies ranging from the loss of the right to receive production and production revenues from the affected well¹⁸ to the outright forfeiture and loss of one's leasehold interest.¹⁹ Article VI also includes the gas balancing provisions that apply should a

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party not take its share of production in kind.²⁰ The application of these provisions could result in a...