LESSEE'S CONTINUING LIABILITY FOLLOWING ASSIGNMENT OF FEDERAL ONSHORE LEASES
| Jurisdiction | United States |
Attorney at Law
Houston, Texas
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Introduction
Just when I think I'm out ... They pull me back in!"1
Lessees often assign their interests to third parties with the belief and expectation that they have transferred not only right, title and interest, but also associated obligations. Demands for performance under the extant agreements years after the purported transfer are expectedly greeted with groans of unfairness, unreasonableness, and contrary to "custom and practice." Lessees therefore are stunned to learn that vis-à-vis lessors, they remain be liable for contract obligations notwithstanding their transfer, absent a novation or relinquishment.
The risk is more acute in federal leases, with a definitional maze of ambiguous, counterintuitive and contradictory provisions where the only practice that holds water is the Bureau of Land Management's ("BLM") consistent application of the rules. This article explores the contours of transfers in federal leases administered by the BLM, identifies the pitfalls that befall holders of record titles and operating rights, and suggests prophylactic drafting measures to avoid continuing unlimited liability following transfers of federal leases.
1. Contract Principles
It is a basic principle of contract law that unless released, a party cannot avoid its contractual obligations by delegating to a third party. The Restatement (Second) of Contracts § 318(3) provides that, "Unless the obligee agrees otherwise, neither delegation of performance nor a contract to assume the duty made with the obligor by the person delegated discharges any duty or liability of the delegating obligor." State statutes contain similar applications: For example, Louisiana Mineral Code Art. 129 states that, "An assignor or sublessors is not relieved of his obligations or liabilities under a mineral lease unless the lessor has discharged him expressly and in writing."2 Texas Business & Commerce Code § 2.210(a) provides that, "No delegation of performance relieves the party delegating
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of any duty to perform or any liability for breach."3 Nonetheless, it appears that this principle is sometimes ignored in oil and gas agreements, supplanted by "industry custom and practice" shown in the Texas Supreme Court case, Seagull v. Eland.4
In Seagull, the court applied the foregoing contract principle in a joint operations dispute to hold that Eland, a non-operator, remained liable to the operator, Seagull Energy E & P, for its share of joint interest billing notwithstanding sale of its interest to Nor-Tex.5 When Nor-Tex failed to pay its share of joint-interest billings, ultimately filing bankruptcy, Seagull sued both Eland and its assignee, Nor-Tex. Eland denied liability because it had no interest in the leases following the sale. The trial court granted Seagull's motion for summary judgment, finding Nor-Tex and Eland jointly liable.
The court of appeals reversed to the extent of the damages awarded against Eland, reasoning that Eland had no continuing liability under the operating agreement following the assignment because the operating agreement did not provide for such continuing liability.6 Seagull appealed to the Texas Supreme Court, and the court reversed.
Finding that no provision of the operating agreement released a party upon sale of its interest, the court recited the general rule that a party who assigns its rights to a third party remains liable unless expressly or impliedly released by the other contracting party. The court found for Seagull "because the operating agreement did not expressly provide that Eland's obligations would terminate upon assignment of the agreement and because Seagull did not expressly release Eland from liability following the assignment of its working interest."7
2. Custom and Practice
While Seagull was based on basic contract law, it generated considerable criticism because apparently incompatible with industry custom and practice. Anticipating the decision, one commentator warned that,
If the Texas Supreme Court takes the Eland case on appeal and ultimately holds, based upon a general principle of contract law, that an assignor and assignee of an oil and gas working interest are jointly and severally liable for costs and expenses arising after the assignment, the industry will suffer results that were unintended by
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the very parties who drafted the relevant agreements. The custom, practice, and general understanding in the industry is that an assignor of oil and gas working interests is no longer liable to the operator and the other working interest owners for the costs and expenses relating to that interest that are incurred after the transfer, including residual liability such as plugging and abandonment.8
It has been observed that "[m]any industry practitioners believe that the decision in Seagull contradicts the current industry practice and will adversely affect the oil and gas industry .... In fact, the independent organization that promulgates the industry's model forms, the AAPL, and the Independent Petroleum Association of America filed an amicus curiae brief in support of Eland. Particularly, the brief noted several independent negative implications that a decision supporting assignor liability after assignment would have on the oil and gas industry."9
Another commentator opined that, "The implications of the Eland decision for the oil and gas industry are enormous. Texas working interest owners have transferred interests in oil and gas properties for the better part of a century under the general understanding that they were responsible for their pro rata share of expenses attributable to the properties while they owned them, but not for those incurred after assignment (emphasis added)."10
Yet one other commentator worried that the court's language "exposes former owners to risks that previous custom and usage in the industry would not have imposed."11 A common strand in these criticisms is that Seagull contravened general understanding and custom and practice in the industry.
The same "custom and practice" which grounded criticism of Seagull in disregard of express contract provisions often extends beyond operating agreements to other oil and gas contracts and likely explains the mistaken assumption that an assignment, generically described as a "sale," relieves transferor of liability. There is a palpable belief in the unfairness of a requiring a transferor who has disposed of its interests and derived no benefits thereafter, to still perform contractual obligations years after the
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transfer. Contractually, assignments and other transfers usually include a provision for the assignee/transferee to assume future risks and obligations and "custom and practice" recognizes that an assignor is not responsible for liabilities created after the assignment.12
Effecting a transfer with the mistaken notion, based on industry custom and practice, that lessee has successfully insulated itself could result in complacency in ensuring that the transferee complies with its contract obligations, and to the contract contains a restraint on assignment, avoid transfer to a potentially insolvent party. Much as such erroneous belief resulted in the game-changing decision in Seagull involving private leases under an operating agreement, it is even more problematic in federal leases administered by the Bureau of Land Management (BLM).
Indeed, it is confounded in federal leases given the apparent ambiguity, lack of precision and resulting confusion in the statutory framework. As in private leases where an assignor, such as Eland, is stuck with the bills long after a sale, a lessee in federal leases may similarly face risk indefinite exposure if it fails to secure appropriate approvals for transfers.
3. Nature of Transfers in Federal Leases
a. The Definitional Maze
Industry parlance distinguishes various kinds of transfers of interest in oil and gas leases: (1) transfer of the entire leasehold estate, (2) transfer of a segregated portion of the leasehold estate or to certain strata or formations ("partial assignment"), (3) transfer of an undivided share of the working interest, or (4) transfer of the working interest for a primary term shorter than the unexpired primary term of the lease ("sublease").13 An assignment means generally "a transfer of a property interest or of a contract."14 Partial assignment means the "transfer of the whole interest created in either lessor or lessee by execution of an oil and gas lease. This transfer may occur in one of two ways: (1) by conveyance of an undivided interest, or (2) by conveyance of part of the tract under lease in severalty."15
The Mineral Leasing Act of 1920 ("Act"), however, commences with seemingly counter-intuitive definitions that differ from ordinarily understood concepts, containing the following pertinent definitions:
(a) Operator means any person or entity, including, but not limited to, the lessee or operating rights owner, who has stated in writing to the authorized officer that it is responsible under the terms and
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conditions of the lease for the operations conducted on the leased lands or a portion thereof.
(c) Record title means a lessee's interest in a lease which includes the obligation to pay rent, and the rights to assign and relinquish the lease. Overriding royalty and operating rights are severable from record title interests.
(d) Operating right (working interest) means the interest created out of a lease authorizing the holder of that right to enter upon the leased lands to conduct drilling and related operations, including production of oil or gas from such lands in accordance with the terms of...
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