CHAPTER 9 ISSUES RELATED TO UNIT TITLE OPINIONS

• Jurisdiction: United States

Federal Onshore Oil & Gas Pooling & Unitization - part 1
(Oct 2014)
CHAPTER 9
ISSUES RELATED TO UNIT TITLE OPINIONS
Steven Butcher
Butcher & Widlund, LLC.
Denver, Colorado
John S. Butcher
Butcher & Widlund, LLC.
Greenwood Village, Colorado

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JOHN S. BUTCHER is a member of the law firm of Butcher & Widlund, L.L.C. in Greenwood Village, Colorado. Steve is a graduate of the University of Oklahoma and the University of Denver Sturm College of Law. Prior to obtaining his law degree, Steve was a landman with Hunt Energy Corporation in Bismarck, North Dakota; Dallas, Texas; and Denver, Colorado, and for Kugler Newberry in Denver. While attending law school he also worked as an independent landman for multiple clients. He was admitted to practice in all Colorado courts, the United States District Court for the District of Colorado, and the 10th Circuit Court of Appeals in 1989. His practice has focused on oil and gas related matters since 1999, including title and transactional matters.

I. Allocation Of Production To Partially Committed Tracts

The Bureau of Land Management ("BLM") classifies tracts within federal unit boundaries using four different identifiers: 1) Fully Committed; 2) Effectively Committed; 3) Partially Committed; and, 4) Not Committed. A Fully Committed tract is one under which all interest owners, working interests, royalty interests, overriding royalty interests, and production payment or net profit interests, have joined the unit area by signing a joiner to the unit agreement.¹ An Effectively Committed tract is one under which all interest owners have signed a joinder to the unit agreement except overriding royalty owners.² (In some instances under fee tracts, a working interest owner may commit the royalty owners to a unit area where the fee lease grants that authority to the lessee under an unitization clause.)³ A tract is not committed where either substantial working interest under a lease or the mineral owners under an unleased fee tract have refused to join the unit agreement.⁴ Unleased federal mineral interests are also not committed to the unit agreement.⁵ In the case of unleased federal mineral interests however, compensatory royalties are owed the United States where the unleased tract lies within a participating area.⁶ (A participating area is that area within the unit that following the drilling of a unit well is approved by the Authorized Officer of the BLM as having been reasonably proved to be productive of unitized substances in paying quantities. Those lands are entitled to participate in the production from the well based on a proportionate basis.)⁷

A Partially Committed tract is one, if a federal tract, where the operating rights owners have committed their interests to the unit agreement, but the record title owner has not joined in the unit. Where the tract is a fee interest, a Partially Committed tract is one where the working interest has joined the unit agreement, but the royalty interest has refused to join the unit agreement.⁸ Under that circumstance royalties are owed to the non-joining royalty owner only if a well is located on the partially committed tract.⁹ In

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that instance, the royalty interest is entitled to its full royalty on a lease basis rather than on a proportionate basis under a participating area. That circumstance results in excess burden and generally the committing working interest owner under such tract is responsible for the payment of that excess burden. Where a unit well is located on a Fully Committed or Effectively Committed tract, the royalty owner under a Partially Committed tract within the participating area is not entitled to royalties.¹⁰

To determine the excess burden owed, consider the following example. Assume, a participating area of 160 acres, where 120 acres are fully committed with a 12.5% royalty rate, and 40 acres are partially committed with a 12.5% royalty rate. If the unit well is located on the 120 acres, the royalties owed would be 9.375% to the 120 acre tract and nothing to the 40 acre tract, absent applicable state spacing. If the unit well is located on the 40 acre partially committed tract, the royalties owed for the 120 acre tract would be 9.375% of production, and the royalties owed for the 40 acre partially committed tract would be 12.5%, resulting in total royalties of 21.875%. Generally, the working interest owner under the partially committed 40 acre tract would be responsible for the additional burden of 9.375% (being 12.5% owed minus the 3.125% proportionately owed if the tract had been fully committed.¹¹

A separate issue to be considered is payment of overriding royalties under an Effectively Committed tract. It has traditionally been considered that overriding royalties under a lease with a unitization provision would be committed when the underlying lease was committed. Two cases have caused some question regarding that traditional thinking. In W.A. Moncrief v. Harvey¹² an assignee of a State of Wyoming lease conveyed the lease reserving a 5% overriding royalty interest. The ultimate assignee and the State of Wyoming both signed joinders to the unit agreement, but the overriding royalty owner, Harvey, refused to sign a joinder. A unit well was drilled on the State of Wyoming, and Harvey demanded payment of his full 5% overriding royalty, refusing to accept a proportionately reduced 5% based on the participating area.

The Court noted that under the State of Wyoming lease at Section 3(c) the lessor expressly reserves:

The right, with consent of the lessee, to commit the herein leased lands in a unit or cooperative plan of development, and to establish, alter, change or revoke the drilling, producing, and royalty requirements of the lease to conform therewith. (emphasis added)¹³

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The Court determined that the phrase "consent of the lessee" applied to a lessee that assigned the lease but retained an overriding royalty, and that the retained interest did not lose the protections afforded by the unitization provision. Since Harvey refused to join the unit agreement, his interest was not bound by that agreement and he was entitled to his full 5% overriding royalty interest of production from the well located on the State of Wyoming lease.

In Wolter v. Equitable Resources Energy Company an assignee reserved an overriding royalty when assigning two federal leases. The reservation language provided:

Said overriding royalty, which is reserved in this assignment, shall be computed and paid on the same basis, in the same manner, at the same time and on the same products, substances and elements, as in the royalty payable to the Lessor.¹⁴

As in Moncrief, the overriding royalty owner refused to sign a joinder to the unit agreement, and sought payment of the overriding royalty on a lease basis rather than a proportionate participating area basis. The Court affirmed the district court finding that because the reservation language was unambiguous, and the federal government as Lessor was being paid on a participating area basis, the overriding royalty should be paid on a proportionate share basis under the participating area.¹⁵

The court looked to the lease unitization clause in one instance and the reservation language in the assignment in the second. The lesson is to always attempt to obtain a joinder from an overriding royalty owner, and if not possible look at both in each instance in trying to determine the basis of payment of non-committed overriding royalty interests. In that examination, be cognizant of the more specific language within each provision.

II. Compliance With State Royalty Payment Statutes When Approval Of A Participating Area Is Delayed

Once a unit well capable of producing unitized substances in paying quantities is completed, a participation area is to be established under the unit agreement.¹⁶ The unit operator is to submit for approval by the Authorized Officer ("AO"), a schedule of all lands then regarded as reasonably proved to be productive of unitized substances in paying quantities. (Paying quantities is defined as quantities sufficient to repay the costs of drilling, completing and producing the well with a reasonable profit.)¹⁷ Where an application to establish a participating area has not been filed within 3 months after

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completion of the well, the AO should contact the unit operator to encourage prompt filing of the application.¹⁸ Once the application for a participating area has been properly submitted by the unit operator, the AO is to approve the participating area within 120 days.¹⁹

Many states' statutory regimes include statutes addressing timely payment of royalties from production. There may be instances where the date of approval of a participating area is in conflict with those statutory requirements. A sampling of the applicable statutes is provided below:

Colorado:

(2)(a) Unless otherwise agreed pursuant to paragraph (b) of this subsection (2), payments of proceeds derived from the sale of oil, gas, or associated products shall be paid by a payor to a payee commencing not later than six months after the end of the month in which production is first sold. Thereafter, such payments shall be made on a monthly basis not later than sixty days for oil and ninety days for gas and associated products following the end of the calendar month in which subsequent production is sold. Payments may be made annually if the aggregate sum due a payee for twelve consecutive months is one hundred dollars or less. (b) The payor and payee may provide, in a valid lease or other agreement, for terms or arrangements for payment that differ from those set forth in paragraph (a) of this subsection (2).

(4) If a payor does not make payment within the time frames specified in subsection (2) of this section and such delay in payment was not caused by any of the reasons specified in subsection (3) of this section, the payor shall...